Canadian Economy 2203 Notes

UNIT 1

Chapter 1

 Economics is the Social Science of Scarcity and Choice  -- the study of the way we make decisions about the use of scarce resources. 

 Economics comes from a joining of Greek words “oikos” (meaning house) and “nemo” (meaning manage).  Thus, roughly translated, the word Economics actually means Household Management. 

Scarcity basically means that there isn’t enough of something.  In any society, the nature of humanity is such that our needs and wants can never be fulfilled… we can’t satisfy them.

 A Social Science is a methodological study of the way human beings behave both individually and in groups.

 A Pure or Natural Science is based on the laws of nature which are eternal and immutable (eg.  2+2 = 4 today and always). 

• Social and Natural sciences differ in that Social Sciences study the constantly changing condition of human behaviour whereas Natural sciences study the unchanging laws of nature.

 Economics is not limited to stuff on the news… whenever we make a decision to do one thing instead of another, we make an economic decision. 

 Economics has to do with using resources effectively and efficiently, thereby making wise decisions… in other words, getting the most out of whatever decision we make because no matter how much we have, we will never be satisfied. 

People as a large group (eg. Society) are relatively predictable… we can assume that on a large scale, if the price of computers were to drop 50%, sales would increase dramatically.  However, while this is the case, there is no telling what each individual of that group will do in any given situation.  Whereas the majority of people would flock to the nearest computer store, Mr. Ivany might stay at home and eat Broccoli instead.

Therefore, it out to be emphasized that while economists can predict the behaviour of a society with relative certainty, it is far less likely that they will be able to predict individual or idiosyncratic behaviour. 

• The behaviour of the group is often predictable, while the behaviour of the individual person is not.  (page 7).

Three Reasons why students should study Economics:

(i)                 Media Overload 

Students are constantly confronted with economic information on television (eg. News), the internet, newspapers, radio, etc…  because of this, it is easy to get confused if they don’t know what is going on or being said.  – Knowledge is power.  Through studying economics, students will be able to understand and decode all of this information.

 (ii)               Decision Making Skills

Economic decisions are not limited to the national and global scales.  Deciding what to do with the ten bucks someone gave you for shoveling her driveway is an economic decision as well.  It may not affect the state of the country, but it is very important on an individual level.  Through studying economics, students gain the skills necessary to choose wisely.

     (iii)             Civic Participation

We live in a democracy… this means that everyone’s voice is important.  To participate intelligently in a vote requires an understanding of how a given politician or political platform will affect the individual, the municipality, the province, the country, etc.

Economics focuses on materials but it is not materialistic… that is, while Economics is concerned with resources, it is also concerned with how people use the resources that are available.  In other words, the resources are not seen as ends in and of themselves, but as means to human ends that are more righteous than personal greed… thus the collection of material goods is meant to augment the furthering of the state of humanity.

Economics does not try to establish goals for the people who study it; rather, it gives them, the tools they will need to achieve their goals more efficiently, that is by wasting fewer resources.  (page 8)

Effective vs. Efficient use of Resources

Choosing wisely involves making decisions that result in the minimum wastage of scarce resources.  Thus, we are not merely concerned, from a standpoint of economics, with achieving our end goals (being effective) but also with only using the resources that are necessary (being efficient).

 To get the job done is effective, to do the job using only what one needs is efficient.

 Efficiency enables us to use the saved resources [the ones we didn’t waste] in achieving other goals – goals that we may not have been able to achieve unless we had economized (page 8).

 Economists are concerned with efficiency because the notion of scarcity is at the very core of every decision.

 Even when we economize however, we must realize that by using a resource to achieve a particular end, we necessarily loose the opportunity to use that same resource for another end (Opportunity Cost).  Thus we must not only consider what we gain from a decision but also what we have lost.

 Opportunity Cost the sum of all that is lost from taking one course of action over another.

 Because Opportunity Cost is involved in any decision, it is useful to have a clear view not only of the choices but of their outcomes.  Thus we employ a decision making model.  The general model that we shall make use of in this course has nine steps: 

1. Define the problem.

2. Clarify goals and priorities.

3. List the possible alternatives.

4. Establish the criteria used to judge the alternatives.

5. Weight each criterion based on goals and priorities.

6. Evaluate each alternative.

7. Make a decision

8. Act on the decision.

9. Assess the effectiveness.

 It is often helpful to use a decision making matrix in combination with the decision making model to help one visually interpret the best decision.  Through using these techniques, it is easier to make a more efficient and effective decision that is not based on personal biases and feelings as much as it is on logic.

Facts and Values

Facts and Values help economists to make logical or rational decisions.  They are, however, quite opposite of one another and as such, they have been referred to as “the two sides of the economic coin” (pg. 10)

 Analytical(or Positive)  Economics

• Concerned with two types of statements:

(i)                 descriptive:  statements which portray things as they are in the present or have been in the past

(ii)               conditional:  statements which act as predictions or forecasts based on the careful analysis of economic behaviour (often taking the form of  “If…Then” statements).

·        Based on Facts and Figures – recorded and recordable data on which direct and concrete statements can be based.  In the case of conditional statements, these are comparable to extrapolations on a graph… they are not perfectly accurate but there is very little disagreement between economists regarding the possibility that they are true.

Normative (or Policy) Economics

• Similar to the conditional statements in Analytical Economics but based primarily on how one or a few individuals perceive what will happen.

• “Normative statements express what a particular economist or group of economists thinks should be the case, based on their value judgments” (page 12)

• Facts and figures cannot be used to give tangible support to these “value judgments” (aka opinions).

• Normative statements are not statements of irrefutable fact and therefore they are open for debate.

• Normative Economics ought not to be misunderstood to be mere opining… indeed, they are quite valuable.  Just because they are not fact but values (what people think is important) this does not mean that they are without merit.  Indeed, a normative statement by an economist is comparable to a meteorologist predicting the weather… unlike you or I, a meteorologist has examined the facts and figures and makes a value statement in the form of a forecast… meteorologists may disagree, and some are right while others are wrong, but both predictions were valid because of their expertise.  My prediction is not valid because I do not have that expertise to draw on.

 Both Facts and Values… Analytical and Normative Economics… are important, especially as we enter into the 21^st century because both can seriously affect a nation’s global status.  That is, a decision not to trade with another country because of moral and ethical reasons (normative economics), despite the possible financial gains, can have profound effects on a country like Canada.  Thus, whereas turning down great profits may at first glance seem illogical, when examined from a moral standpoint, they are very much based on logic.

The Scientific Method and Mathematics in Economics

A discipline, or field of study, is called a science based not on what it studies but on how it studies it, that is, based not on its subject matter but on its method (the scientific method).  (Page 13)

 The scientific method was first outlined by Francis Bacon:

• Observation

• Data Collection

• Explanation

• Verification

 As Economics is the social science of scarcity and choice, it makes use of the scientific method. 

 Economics also makes use of mathematical principles and techniques to carry out the scientific method (eg. Equations, statistics, graphs, etc.)

Basic Fallacies, Laws, and Theories of Economics

 We have already established that logic plays a big part in Economics as a discipline.  As such, it is important for students of economy to be aware of certain logical fallacies.

 Fallacy:  a hypothesis that has been proven false but is still accepted by many people because it appears, at first glance, to make sense.

 Three important fallacies to be aware of:

 (i)                  Fallacy if Composition:  The mistaken belief that individual benefit automatically translates into social benefit  OR  the mistaken belief that what is good for society automatically translates into benefits for an individual.

(ii)                Post Hoc Fallacy: (aka  cause-and-effect fallacy) is based on the assumption that just because one thing happens after another that the first event causes the second event.  – Sometimes the relationship between two events is more a matter of coincidence (correlation) than cause and effect.

(iii)               The Fallacy of Single Causation: based on the premise that a single factor or person caused a particular event to occur (ex:  in the story of the straw that broke the camel’s back, it was not the straw in and of itself that collapsed the camel, but that straw in addition to all of the straws that went before it.  One might assume that the final straw was the culprit, but it was only the one that hit the camel’s breaking point).

 Correlation:  When two things happen simultaneously or close to one another but have not been proven to exist in a cause-effect relationship.

Economic Laws Affecting Production Possibilities

 Production Possibilities Curve:  A graphical representation of the production choices facing an economy.  It provides a visual model of those production choices.

 Trade Off  the increased production of one good can only be achieved by sacrificing a sufficient quantity of the alternative product.

 Two Types of Goods:

(i)                 Consumer Goods: those products and services that directly satisfy human wants and needs.

(ii)               Capital Goods:  those goods used in the production of other goods.

Labour Force:  The total number of people in a society who are able to work whether they are presently employed or not.

 The Law of Increasing Relative Cost:  This law comes into play whenever a society, in order to get greater amounts of one product, sacrifices and ever-increasing amount of other products… the increase in one product is directly proportional to the opportunity cost of another. 

Frontier:  The outer limit of a thing.

 The graph of the maximum potential output for any product is known as the frontier of production possibility and is attainable only if ALL productive resources are fully employed.

 The Frontier of Production Possibility is not a realistic goal for any society or any product… it is theoretical in that there is no perfect system in which all resources are constantly and consistently used to their full potential.

 The Law of Diminishing Returns:  this law deals with the relationship between an input and the resulting output.  It states that outputs will increase when a particular input is increased, but only to a point… after this point has been reached, increasing inputs will not have an appreciable effect on the production of outputs.

• For any productive enterprise, when at least one input is held constant while other inputs are increased, there will be an eventual decline in the rate of extra output or yieldage. (Page 19)

 The Law of Increasing Returns to Scale:  The increase in the rate of extra outputs produced when all inputs used in a production are increased and no inputs are held constant.  It involves an increase in the scale of all inputs.

• Since in the real world productive resources are liminted, it is not always possible for an enterprise to increase all resource inputs indefinitely.  Ultimately, therefore, the availability of some productive resources will end, and the law of diminishing returns will once again prevail (page 20).

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Chapter 2

Productive Resources are anything that can be used to manufacture goods and services.

Originally, economists only recognized tangible resources, that is physical resources that are necessary for production and are visible. These three resources are land, labour, and capital.

Land refers to the soil and all natural resources found on or in it. Mineral deposits, groundwater, fossil fuels, and forest resources are raw materials included in the land resource.

Labour includes not only physical work, but things like mental effort, and all other things humans contribute to the production of goods and services.

Capital refers to all the goods that are used in the production of other goods and services. There are two kinds of capital, real capital, which is more precise than just capital, are resources such as factories, warehouses, machinery, and equipment used to produce goods and services, and money capital, which are the funds used to acquire real capital.

One of the most important factors in a growing economy is real capital. Investing in capital goods at first, increase productivity and efficiency in the long run. Productivity is a firm’s ability to maximize output from the resources available.

Over time, economist realized that there were more than just tangible resources contributing to the production resources, that there were also resources that are not visible like tangible resources, but are just as important. These resources are called intangible resources. In tangible resources can also be broken up into three groups, knowledge, entrepreneurship, and environment for enterprise.

1. Knowledge is becoming a more and more important resource to production. This is true in Canada because we have switched from a manufacturing economy to an information economy. We use knowledge to increase our information, thereby increasing productivity.

2. Entrepreneurship includes the risk-taking and organizational activities that the economy needs to have and increase in production levels and in production efficiency. Entrepreneurship is directly linked to the national productivity of Canada.

3. Environment for enterprise is a society’s social values and instructions that are favourable to businesses attempting to produce and sell goods and/or services. In order to evaluate the conduciveness of the business, the social and cultural values and political and economical institutions of the entire country must be examined.

In the final analysis, tangible and intangible resources work together to form the real source of a nation’s wealth and prosperity. (Page 28)

Value added is the increase in market value of a product resulting from additional processing or refinement of that product.

            Throughout history, economic systems have been established to answer the three fundamental questions:

What to produce?

-What goods are to be produced?

How to produce?

-How does one produce the goods, and how much of the goods are to be produced?

For whom to produce?

-Who are the goods being produced for?

Economic system as the set of laws, institutions, and common practices that help a nation determine how to use its scarce resources to satisfy as many of it’s people’s needs and wants as possible. An economic system helps answer the three fundamental questions: What to Produce, how to produce, and for whom to produce?

Note: The three fundamental questions can be answered by tradition, command, and by market forces.

The Traditional Economy 

            In a Traditional Economy the three production questions are answered by how they were answered in the past. The goods and services are still produced as they were in the past. Nothing has changed.

             In a traditional economy what to produce is decided by the needs of the producers, in which they use for their own personal use, which also answers the question for whom to produce? Any goods needed that they do not have, is barter. Barter means to trade one thing for another. How to produce goods is by the knowledge passed down to them. A family for example, they produce food for their selves to eat, and the parents pass the knowledge of how to produce it down to their children.

The Command Economy 

            In a Command Economy, a small political group answers all production questions. In addition, a Command Economy is usually planned. The individual person serves the small group and in return, the group will provide the individual with food, housing, medicine and education.        

Command economies rely on a system of reward and punishment to increase productivity. If the workers co-operate and do the work without complain than they are rewarded, but if the workers decide not to co-operate than they shall be punished.

A command economy produces more capital goods than consumer goods because capital goods increase the economy’s production later on in the future.

            Two best examples of command economies are Cuba and China. All communist countries are command economies.

The Market Economy

             In a market economy, many individuals make their own decisions. This system is also called free enterprise, which means anyone can own his or her own business. Since there are privately owned resources, the system is sometimes called private enterprise.

            The individuals answer the three production questions. What to produce is answered by consumer demand. Businesses with the demanded goods and services will receive the highest prices.

            Consumers prefer low prices because there is a higher demand for low prices, which answers how to produce? Producers can maximize their profits by using the most efficient methods of production or make things that are cheap so everyone will buy the product.

            How much money people get or income answers for whom to produce? People with more money can buy more national output than people with less money.

Mixed Economy: An economic system, such as Canada’s, that contains elements of market, command, and traditional systems.

Crown Land: A Canadian term for land owned by the government.

Hidden Economy: The growing practice in Canada and other mixed economies of citizens trading one service for another to avoid taxation or to ensure a more personal level of services; illegal transaction occurring in the economy that are not recorded in GDP (Gross Domestic Product) calculations (such as payments of employees “off the books”); and non-market production.

Democracy: Is a political system characterized by a freely elected government that represents, for a set term of office, the majority of the citizens. It is open to many parties or political views.

Dictatorship: Is a political system in which a single person or party exercises absolute authority over an entire nation. There are no free elections to allow the people to change their leadership.

Communism: is a political model based on the theories of Karl Marx, Friedrich Engels, and Vladimir Ilyich Lenin. It calls for government or community ownership of all means of production and wealth.

Socialism: A political system of the moderate left that calls for public ownership of the principal means of production, to be achieved in a democratic and peaceful manner.

Nationalization: Another term fro state ownership of business enterprise.

Capitalism: An economy characterized by private ownership of business and industry, the profit motive, and free markets.

Fascism: A political system on the extreme right, combining a free-market economy with a non-democratic form of government.

A diagram which offers an overview of politico-economic models (reconstructed form p. 35 of the text)

Canada: A Mixed Market Economy

Two reasons why there are not any real “pure” economies, in terms of it is 100% categorized as a command economy, traditional economy, or a market economy:

-         No one type of economy has reached perfection. Not one of the three types has met all of the needs and wants of the people in neither of their cases.

-         Because we know each of the types of economies have some good parts to them and because we know that a “pure” economy of either sort cannot be met, people integrate different aspects of each type of economy into their own

An example of this is the Canadian economy. Even though it contains elements of both command and traditional economy, it most predominant aspects are that of a market economy. For this reason Canada’s economy is classified as a mixed market economy, which means our country supports both private enterprise (market and traditional economy) and state-owned enterprise (command economy). Uses example of CTV and CBC in text (page 34 on top). CBC is state owned while CTV is privately owned. CBC is a non-profit television network (a public service) while CTV is a profit network. The two networks are somewhat different but they are sometimes in direct competition with each other. For example, they may both want to have the rights to the coverage of the Olympic Games but only one station get them so they have to compete.

Canada tries to take the best aspects of each of the economic systems and put them together and makes it into something new, their own economic style/type. For example, with ownership of land, Canada (state) owns the land so everyone owns the land but it also promotes private owner ship of land, which is an aspect of market economy. So in this particular place, Canada uses one aspect of one economy but it also uses and aspect of another.

            Though there is a lot of free enterprise in Canada, the government has set a lot of regulations that businesses have to regard. Also, Canada uses a safety net if you will for its people. Canada is welfare state so the government gives the people paid medi-care, employment insurance (ei), social security for senior citizens, and if a person cannot get a job, the government will give him enough money for the necessities of life (food, shelter, etc…). These programs would not be found inside a pure market economy.

            Canada also has parts of a traditional economy within it as well. For this we go back to one of the most basic elements of traditional economies with barter. In Canada, people can trade pretty much whatever they want to someone else in turn for something. For example, if a cabinet maker wants his house re-wired and an electrician wants a new set of cupboards put in, the cabinet maker may say well if you re-wire my house, I’ll put in a new set of cupboards and we’ll call it even. Both sides get what they want and they can leave it out of their taxes so it does not cost them any extra money. This is known as hidden or underground economy. Even if the motive is to innocently keep them both from paying taxes (which is illegal) or to endure a more personal level of service, it still puts an aspect of traditional economy into Canada’s economy.

Understanding Political Economics

-         Political systems and economic systems go hand in hand (connected)

Basically two types of political systems:

-         Democracy, which is basically a system where everyone has a fair say, everyone gets to vote. The government is composed of people elected by society. It is opne to many parties and political views.

-         Dictatorship, which is basically a system where one person or group of people are in charge of the entire nation and have absolute power. There are no elections which means no one votes which means the government is not elected and thus the people cannot change their leadership.

**Look at figure 2.8 on the bottom of page one which exaplins left and right wing governments.

Communism

**Political model based on theories of Karl Marx, Freidrich Engels, and Vladimir Ilyich Lenin.

            Basically, communism is a political system is as system where everyone is equal. No one person has any more or any less than the person next to him. The wealth is evenly distributed throughout society, which means no one is rich and no one is poor, everyone has enough to live. For this reason, private ownership and private enterprise are abolished. Each person does what he or she are told to do and do it to the best of their abilities. For example, if the government tells you to make shoes for a living you make shoes, no questions about it. In order for this system to work it needs a very strong government and opposing forces such as other political parties and labor unions and such must be abolished or have no say in any of the decision making. Communists are willing to use force to reach their goals. It is seen as the extreme left in the political spectrum.

**Two examples of communist states are China and Cuba.

Socialism

            (Occupies the moderate left in the political spectrum) Also believes in public ownership and enterprise. However, unlike communists they do not use force or the threat of force to reach their goals (they/it is peaceful). People have some say in how the country is run as they get to vote for who will form the government. The party in power does not abolish opposition parties. For these reason they are often called socialists democrats and thus they fit in the moderate left wing of the political spectrum. Socialists try to create an equal distribution of goods/services using a democratic decision making process (the people decide). Though unlike a true democratic system, they classify free enterprise as wasteful and inefficient. Within socialism, co-operation replaces the capitalist’s idea of self-interest and competition in an economy. The main reason why socialism does not work is because of human self-interest. People are greedy little things and are always looking out for number one so they want more money than everyone else and a bigger house and so on.

            Free enterprise socialism is where everything I the same as socialism except for private enterprise is allowed, but taxes and such are taken out and distributed to others as a welfare type thing, which still helps to even the distribution of goods/services in the society. Some examples of such systems exist in Norway, Sweden, Denmark, and Sweden.

Capitalism

            Is a more democratic state. People vote for who they wish to be elected into government so they chose who would run their country and keep the competition between people/businesses fair as it supports private enterprise. Basically, the capitalist way of government says that you can produce as much as you want as long as you do not take away from other businesses too much. It is survival of the fittest with a little alteration. Producers are motivated to produce as much as a product as they want. The can maximize their profits if they can sell it (as long as consumers want to and can buy it). This means that the economic reasoning of opportunity for profit and the threat of loss come into play, and they play the same role in capitalism as a dictator’s opinion/value judgment does in a command economy.

**It is located at the moderate right of the political spectrum.

**Some examples of capitalist states are Hong Kong, United Sates, and New Zealand.

Fascism

**Located at the extreme right position on the political spectrum.

            It combines the aspect of free enterprise with an authoritarian form of government, which means they can/will use force to get their way (social control). The government in control does not usually tolerate opposition parties. All citizens are free to own property and businesses as long as they comply with government regulations. There are restrictions on how much freedom the people within a fascist state can have. So basically, not everyone is equal, people can make as much money as long as they want as long as they come in under government rules, but they do not have any say in how their nation is ran.

**Some examples of fascist states are Spain (1939-1975) and Argentina (1946-1983)

Complementary goal: when reaching one goal makes it easier to achieve another goal.

Conflicting goal: when reaching one goal makes it more difficult to achieve another goal.

Public debt: the total debt that the federal and provincial are in because of borrowed money in the past, on which interest is paid.

Economic growth:  an increase in total amount of an economy’s production of goods and services.  It is represented as an outward shift in the economy’s production possibilities frontier. 

Transfer payments: taking the extra money from one province and giving it to another who needs it more. 

Inflation: a general rise in prices.

Deflation: a general fall in prices.

Setting Economic Goals: A Canadian Model

Every political economic system establishes goals as a target, which will help them focus on productive resources in the future. The setting of these goals is a matter of normative economics. This means that the government has to make a value judgment in what they think will help the economy.  They have to make a list of their priorities and decide what they believe is most important in the future. 

Some economic goals that the Canadian government has set

Political stability

A stable government can help an economy in its long term planning and investing. If the government is unstable then it can cause many other things to become unstable or instability in other things in the economy can cause the government to become unstable.

Ex: Each time Quebec tries to go out on its own, it causes the government to look as though it is unstable.  This instability can cause problems for the economy such as upsetting the US stock market.

Reduced Public Debt

1970- 1996 – The Canadian government was spending more then they could collect back in taxes. This meant that Canada’s public debt was growing larger and larger, while affecting the economy at the same time.

Economic Growth  

Economic growth is an increase in the production of goods and services in an economy.  This can result from the discovery of a new natural resource, an increase in the skilled labour force, technological innovations, etc.  All of this money being produced can lower the public debt. 

Increased Productivity and Efficiency  

 This means that the maximum number of scarce resources are being produced using the least amount of resources available to get as much as possible out of them.  In other words putting enough money into something in order to produce it but making sure that a profit can be made.

Equitable Distribution of Income 

Equaling out the amount of money that the federal government gets come in, among the province is one of the main economic goals.  However, it is also the most controversial as well.  The government has to think about the number of people in each province, living standards, etc.  For example they would not give Newfoundland the same amount of money as they would Alberta.  This is where transfer payments come in.  For example lets say that Alberta pays the federal government $2 000 000 a year and Newfoundland pays $600 000 a year.  When it is time for the federal government to give the provincial government money Alberta only gets $1 500 000, but Newfoundland gets $ 1 100 000. Really you could say that Alberta gave Newfoundland that $500 000. 

Price Stability

 Stable prices indicate that an economy is healthy.  However, increasing prices and decreasing prices indicates that an economy is somewhat struggling. 

Full Employment

In an attempt to reach their optimal production targets, the government tries to promote the full employment of the labour force.  Although, this is somewhat difficult because many machines are now being put into place instead of humans.  

Balance of payments : National account of international payments and receipts divided into current account and capital and financial account.

Consumer Sovereignty: A principle of market economies that the production choices of the economy are ultimately made by the buying decisions of consumers.

Global economy the international flow of gods and currency in transactions such as importing exporting borrowing and lending has become icreasingly more important. If Canadians import significantly more than we export there will be a negative effect on employment rates in Canada as well as the foreign exchange value of the Canadian dollar. It is important therefore that imports and exports roughly balance one anther.

Economic freedom refers to the freedom of choice available to workers consumers and investors in the economy. In a market economy consumers should be free not only to purchase the goods and services of their choice but also through their purchasing decisions to determine what goods and services are actually produced.

Economic activity must be carried out without significantly harming the natural environment. If we wish to be more responsible stewards of our plants. We have to adjust the way we carry out our economic activities. Even if this means higher prices for consumes and lower profits for producers we must find a way t reduce the negative effects we are having on the natural environment

Potential problems can arise i Canada enacts environmental laws that make its products moe expensive and its trading partners do not follow suit. This situation can result in making Canadian goods less competitive in world market.

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Chapter 3

Terms

 Physiocrats: A believer in the 18^th-century philosophy that argued that laws created by humans are artificial and unnecessary because they interfere with natural laws, such as an individual’s pursuit of self-interest, which would ultimately benefit all of society. 

 Laissez-faire:  A French term meaning “leave to do” or “let alone” which became associated with the idea that an economy operates best if individuals are allowed  to pursue their own self interest without government interference.

Mercantilism: An economic system that emphasized state control of trade, with the goal of exporting as many goods as possible and importing as few foreign goods as possible.

 Protectionist: A policy of limiting imports through tariffs.

 Tariffs: A tax on an import levied by a nation: also called custom duty.

Bourgeoisie: Term used by Karl Marx to describe the industrial capitalists that he theorized would be overthrown by the working class people

 Proletariat: Term used by Karl Marx to describe the working class, who he theorized, would rise up and overthrow the bourgeoisie, or the industrial capitalist 

Industrial revolution: The period of innovation and factory production, beginning in Britain in the late 18^th century, that eventually changed the economy from one that largely agriculture and rural to one that was industrial and urban.

 Self-interest:  An idea, central to the philosophy of Adam Smith, that each individual’s strongest drive is to better his or her own condition.

 Invisible hand: Adam Smith’s notion that the unintended result of an individual producer’s desire for profit is the supply of the whole society with the goods and services it needs, together with reasonable price levels ensured by competition.

 Division of labor:  The specialization of workers in a complex production process, leading to a greater efficiency.

 Law of accumulation: Adam Smith’s theory that businesspeople who invest  a percentage of their profits in new capital equipment increase the economy’ stock of capital goods, thus ensuring economic growth and future prosperity. 

 Law of population: Adams Smith’s theory that the accumulation of capital by businesspeople requires more people to operate the equipment leading to higher wages, which in turn lead to better living conditions, lower mortality rates, and an increase in population.

 Geometrical progression: A number sequence (such as 2, 4, 8, 16, 32, 64…) that has the same ratio (in this case, 2) between each number in the sequence; associated with the population growth in the pessimistic theories of Thomas Malthus.

 Arithmetical progression – A number sequences (such as 1,3,5,7,9,11,13…) that has the same difference (in this case,2) between each number in the sequence; associated with food production in the pessimistic theories of Thomas Malthus. 

 Positive checks – Thomas Malthus’s theory that war, famine, and disease would check population increases to some extent, but not enough to prevent the geometric progression of the worlds population to unsustainable levels.

Preventive checks – Thomas Malthus theory that late marriage and sexual abstinences would help reduce the birth rate to some extent.

Biography of Adam Smith

Adam Smith is known today as both the “father of modern economics” and “ the founder of capitalism” 

• Adam Smith was born into a middle-class family in a fishing village near Edinburgh, Scotland.

• At the age of 27, Smith was offered a position at the University of Glasgow. In 1758 he became the dean of the same school.

• In 1759, Adam Smith wrote his first book “The theory of sentiments”. This book made him famous throughout Great Britain.

• In 1764 he became a private tutor. While traveling as a tutor, Smith began his most important project, “The Wealth of Nations” This book took him 12 years to complete and have published.

The times

• Adam Smith was born into a world where mercantilism was the prevailing economic system. This system is based with the goal of exporting as many goods as possible abroad, while at the same time, importing as few foreign goods as possible.

 Many of the ideas that Smith developed in response to the rapid economic changes he observed in Great Britain. One such event that influence some of his ideas was the Industrial Revolution.

 Biography of Thomas Robert Malthus

Introduction 

• Malthus was the first professional economist.

• Malthus challenged Adam Smith’s view of the world, which said that the natural environment provided increasing prosperity, and predicted poverty and hunger for the world.

• Published a book of his views in 1798 called An Essay on the Principle of Population As It Affects the Future Improvement of Society.

• Malthus was very pessimistic (he had negative views of everything), and, after reading his work, economics was referred to as “the dismal science”, which means people looked at economics as a dark or depressing sience.

Biographical information:

• Born in 1766, died in 1834.

• Malthus attended Jesus College at Cambridge University in 1784, and earned a Master of Arts degree in 1791.

• Malthus was ordained into the Anglican Church in 1797, and later became an English curate.

• He was the first professor of political economy, which is why he is said to be the first professional economist.

Times

• Malthus’ theories were greatly influenced by the economic conditions of Britain.

• Britain was undergoing an Industrial Revolution, a time when people abandoned their ways of living off the land and flocked to cities to work in factories, and other, more industrialized jobs.

• The people lived in small, unsanitary places, and struggled to survive on the minimal wages they were paid.

• Also at that time, Britain was in the mist of a war with Napoleon Bonaparte’s France, which added to the hardships of the lower classes of Englishmen.

Malthus’ Theory on Population and Food Production

·        Malthus based his ideas on two basic principles.  One was that food was necessary for human survival, and the other was that humans would continue to reproduce.

·        Malthus built a statement around these two premises, saying that the human population would double every 25 years, or with each new generation.  This is called geometrical progression, where any number in a given sequence has the same ratio.  For example, in the sequence, 2,4,8,16,32… the number to number ratio is 1:2.

·        Malthus believed that food would only increase in arithmetical progression, which is where any two numbers in a given sequence have the same difference as the other numbers.  For example, in the sequence, 1,3,5,7,9… the common difference is 2.

·        This posed a problem, because the amounts of food wouldn’t be able to keep up with the continuously expanding population.  So, more and more land would need to be cultivated, but the land would become less fertile, therefore how much each worker could produce would diminish.

·        We can use the law of diminishing returns to explain Malthus’ theory.  The law of diminishing returns is the eventual decline in the rate of extra outputs produced that occurs when on input used in production of the input is held constant and the others are increased.  Because the land available for farming would eventually run out, it didn’t matter how many extra workers you put there, the amount of food cultivated would never increase enough to match the amount needed.  This theory became known as the Malthusian dilemma.

·        In the Malthusian dilemma, what begins as a balanced state, which is what the economy was at Malthus’ time, would eventually become unstable do to natural progression.  Figure 3.1 shows the Malthusian dilemma. 

·        Malthus also believed that if a the wages went up, the standard of living would increase, which would in turn reduce infant mortality rates, or the number of infants dieing.  This would increase the population at an even faster rate than Malthus had first predicted.

·        Malthus took into account two types of population controls, but he didn’t think they were functional enough to fully control the population.  The first was positive checks, which increase the death rate, and include such things as war and famine, and preventive checks, which reduce the birth rate and include things like late marriage and sexual abstinence.

·        Two things happened that had a major contradiction to Malthus’ theory.  The first was a series of agricultural breakthroughs in the way of technologies.  This period was called the Green Revolution, and food productions increased to amounts that Malthus never predicted.  Plus the continued urbanization had a negative impact on the birth rate, because although big families were ideal for agricultural living, they hindered survival in a large center.

Biography of David Ricardo

            David Ricardo assailed Adam Smith’s notion of a world living in harmony governed by natural laws. Ricardo was the son of Dutch merchant banker who immigrated to London and made it big on the London stock exchange.

            David Ricardo was born in London in 1772 and at the age 14 he was working in his father’s investment business. By the time he turned 22 he had his own business with a capital of 800 pounds and retired at the age of 42 with over 1 million pounds.

            Ricardo was able to use his knowledge of securities to make profits. For example, when Napoleon came back into to power in France no one kept investing in securities where as Ricardo did not stop investing and after the war he was rich.

            When Ricardo retired at the age of 42 he started devoted his attention to the science of political economy. He wrote a famous book in 1817 based on free enterprise capitalism. The book challenged the land lord class (collects rent from land titles they held) and was hailed by the industrialist class (owners of businesses and plants in which employs the working class).

            He was elected to the house of commons in 1819 and argued on behalf of free trade and outlined the laws of land rent which allowed the land lord class to exploit land, labour, and capital. He died in 1823 at the age of 51.

The Times

            Due to growth population and the Napoleonic War there was a drain on food reserves.

            Unlike Adam Smith Ricardo identified the three main conflicting groups:

• Industrialist class – business and plant owners

• Working class – works for the industrialist class

• Landlord class – collects rents from land titles they own

Where the working class struggled to stay at subsistence levels and the industrialist had no representation in parliament the landlords would always prevail. To prove this Ricardo used the Corn Laws. Since there was a shortage in grain and it had to be imported taxes were rose so in order for the working class to survive the industrialist had to pay the workers more which cut into their profit. In the 1840’s the industrialist broke this law and slowly began replacing themselves as the dominant class.

Ideas That Advanced Economic Thought

The iron law of wages

            Ricardo reasoned that, where workers rate of production was unchecked. Than their wages would not increase or decrease and would stay the same no matter how much they worked. Higher wages would not mean higher living standards because the wages would have to be distributed among a larger family.

            The industrialists stopped this and kept their workers’ wages to lowest as possible by saying the workers are performing public service. This kept the working class as the lowest class. Ricardo thought that wages should be determined by free-market conditions.

The theory of the comparative advantage of trade

            When one economy can produce a good or service more efficiently than another is called absolute advantage. For example, one community can produce wool more efficiently than the other but the other community can produce grain more efficiently than the first so trade or absolute advantage occurs. Ricardo recognized and explained that even if one economy can produce two goods efficiently there are comparative advantages when both communities trade the products they can each produce most efficiently. A comparative advantage is when an economy can produce a good or service in comparison to other economies more efficiently. For example, lower opportunity cost.

            Ricardo believed in free trade where two economies and/or countries trade goods and services in exchange for other goods and services. Britain discouraged trade with other countries and raised many tariffs (prices) on imports. This protected the earnings of the landlords and hurt the workers and industrialist where from Ricardo’s perspective the landlords grew rich while the others done all the work and assumed all the risks. Where the industrialist had no representative in the parliament Ricardo quickly became the parliamentary champion of the industrialist.

Biography of Karl Marx

• Was born May 5^th, 1818 in the city of Trier in Rheinish Prussia…died in 1883

• Was an excellent scholar and attended Bonn University, where he studied philosophy

• Became the editor of a small, middle-class liberal newspaper

• One of his first editorials to get him in trouble with the government was one denouncing (publicly saying that you have nothing to do with a person or a thing…ie. A law) a new law set by the government. The law kept peasants form going into the forest and collecting dead and fallen wood for firewood as they always done and which he considered, was their born right. Authorities censored and then closed the newspaper. One by one, each of the newspapers he wrote for were censored.

• As his ideas got more revolutionary and radical (I guess they contradicted the way the government ran things) he had to flee Germany, first to Paris, then to Brussels, but his troubles followed him everywhere until he moved to London, England in 1849.

• He lived with his wife and family in pretty much poverty for the rest of his life.

• His most comprehensive work, Capital (Das Kapital in the original German text) was published in three volumes, one in 1867, one in 1885, and one in 1894. In this text he basically said and explained why capitalism would eventually destroy itself.

• Engels completed book after Marx died in 1883.

The Times

·        The industrial revolution had an ill effect on the working class

·        By the time that he had died in 1883, England had transformed from an agriculture and artisan-based economy to an economy where the dominant mode/way of production was the steam-powered factory

·        Workers lived in the slums of crowded cities and worked long/hard 18-hour days in very unsafe and ultimately unclean factories

·        Children had to endure the same hardship as there were no laws against child labor

·        Children could not get an education as they had no time (were always working and when they were not they were sleeping:) ) and thus there was no way for them to get out of this situation; working hard days. The could not get out of it as they needed an education to get a better job and seeing as how they couldn’t get an education, they could not get out.

·        He (Marx) saw that all of the wealth in a society was achieved by the backs of the workers, and yet the workers received very little money or benefits from their employers

·        Marx believed that capitalism was morally wrong (it defied all sense of morality) and that it would one day destroy itself.

Ideas That Changed Economic Thought

The Economic Interpretation of History

• Thought that the laws of economics determine the course of human history

• He saw/believed that history was basically a continuing fight between classes in society (free citizens against slaves, lords against serfs, patricians—people of fine up bringing; rich; high class in society—against plebeians—basically, common people; lower class—, and of course industrial capitalists against workers)

• Whenever the situation becomes unbearable, the oppressed rise up and rebel against their oppressors

• He thought that because the capitalist has exploited the workers and have given them long, hard labour with barely any wages, the situation would soon reach its ultimate peak of hardship (on the side of the workers) and the workers would rise up against the industrial capitalist (the rulers basically) and over-throw them, thus sending it to its doom

The International Communist Revolution (revolutionary socialism)

·        Believed that this revolution would happen in the most industrialized countries in Western Europe, where of course, capitalism was strongest and thus exploited the workers to the greatest extent. It would eventually spread throughout the entire world

·        As a result of this revolution, international socialism would now be the governing body, if you will. Its basis would be common ownerships of land and capital (money and such).

·        From socialism the world would eventually turn to the pure state of communism

·        A society based on the fact that the workers (along with basically everyone in society) would govern society.

·        Based on its guiding principle of, “from each according to ability, and to each according need”. So each person will do what they can do, ability wise, and each person will get things such as food as such, according to what they need.

The Labour Theory of Value

• Marx believed that the value of an item could only be measured by the amount of labour put into it. Not only the labour by the workers also the labour in the sense of the machinery use din the making of the product and the building it was manufactured in and so on

• In capitalist society, workers only receive a small amount of what their labour is worth, the difference between the money they actually get (and also includes benefits and such) and what they should receive is known as surplus value, or at least to Karl Marx it was. Basically, it is what is stolen from the workers and in turn it produces a profit for the capitalist.

• Example in book:

A company makes sweaters. They pay the workers $40 in labour to knit the sweater, they spend $5 in materials, and $5 on wear and tear on machines. This equals to $50 in expenses. They sell the sweaters for $80 each. If the it were to work out in the communist way, seeing as how they pay $10 for indirect labour, then the direct labour must be $70, but in this case the amount they are paying the workers is $40, and plus the $10 you have $50. This means that there is $30 created from this process (the amount of worker exploitation/mistreatment). Marx’s ideas say that this should have gone to the workers but it was stolen from them (surplus value) and this is what creates a profit for the capitalist (a profit of $30 on every sweater).

The basic idea (in terms of employment) in a capitalist system is that the worker will always produce more than the employer will ultimately have to pay in wages. Workers are forced to sell their labour for less because they need their jobs. If a person were to say that they want more money, the capitalist would fire him or her, and hire another poor schlep as there are plenty more fish in the sea in these cases (there are a lot of desperate workers). This assures that the wages that the employers have to pay will never rise above what they wanted to be.

Biography of John Maynard Keynes (1883- 1946)

• Published The General Theory of Employment, Interest, and Money in 1936.

• Also provided an explanation of how government intervention could save a country from low unemployment rates.

• He was born in Cambridge, England.

• Taught economics at Cambridge University.

• He gave important advise to the British treasury during both World Wars.

• Appointed a director of the Band of England.

• Also served as editor of a major economics journal, chair of an insurance company, and manager of an extremely successful investment trust.

• Won British women the right to vote.

The Times

Keynes’ career lasted throughout the two World Wars and the Great Depression as well. The Great Depression of the 1930s was a difficult time for both North America and Europe. At first governments believed that the extremely high unemployment rates were only temporary and that their economy would soon come to a more balanced state.  In fact governments were one of the reasons the Great Depression lasted as long as it did.  They encouraged people to not try to get work.  They told people to just lay back and make due with what they had, which in turn cut down on the amount of money in circulation.

In fact, government attempts to cut spending and pay back war debts contributed to a decline in the account of money in circulation.  (P. 59)  

Ideas that Advanced Economic Thought

 War and sustainable peace

After First World War ended Keynes went as a representative to a peace conference, where he strongly criticized the Treaty of Versailles.  He said that this would ruin the German economy by making them pay money to countries that were damaged in the war.  It was because of this that Keynes resigned form the British government.

            When the Second World War came along Keynes served as a key economic adviser to the British government. It was here he came up with the idea of “deferred savings” where some money from every workers paycheck would be taken and invested in the governments war bonds that could not be cashed until after the war.

Combating the Great Depression

In The General Theory, Keynes expressed his thought on an unusual idea.  He said that government was responsible for a large part of the high unemployment rates ushered by the Great Depression. He believed that these rates could be lowered if the government sponsored more public work project that would give people jobs.  Keynes said that when people limited their spending to the size of their incomes they were not making much of an investment. There fore he suggested that one of the main causes of the Great Depression was little investment. 

Biography of Milton Friedman (1912- )

Born in Brooklyn, New York.

Friedman has a conservative view of political economics.

Appointed as a government economist for the U.S. during the second world war, after which he took a job as a professor at the University of Chicago in 1947 and kept until 1977.

Received the Nobel Prize for Economics in  1976

In addition to his scientific work, Friedman has also written extensively on public policy, always with a primary emphasis on the preservation and extension of individual freedom. His most important books in this field are (with Rose D. Friedman) Capitalism and Freedom (University of Chicago Press, 1962); Bright Promises, Dismal Performance (Thomas Horton and Daughters, 1983), which consists mostly of reprints of columns he wrote for Newsweek from 1966 to 1983; (with Rose D. Friedman) Free to Choose (Harcourt Brace Jovanovich, 1980), which complements a ten-part television series of the same name shown over the Public Broadcasting Service (PBS) network in early 1980; and (with Rose D. Friedman) Tyranny of the Status Quo (Harcourt Brace Jovanovich, 1984), which complements a three-part television series of the same name, shown over PBS in early 1984 (http://www-hoover.stanford.edu/bios/friedman.html)

Friedman began his college education at the beginning of the Great Depression, thus he was strongly influenced by the way the government of that time handled its situation during such a crisis.  Additionally, he was influenced by “the amount of unproductive government intervention in the US economy following the end of WWII” (page 63).   Attempts to handle the situation on the part of the government, according to Friedman, weakened every individual in the country, and as such, the economy of the country as a whole, by making it dependent on government intervention.

Friedman’s views are reminiscent of those postulated by Adam Smith, hence his theories are referred to as laissez-faire capitalism.  Basically, this means that in a market economy/Capitalism, he believes that it is best to leave things alone and let the market resolve itself.  In other words, make people and businesses fend for themselves without government help… that this will result in an economy that is made up of only the strongest and most efficient individuals and businesses because those that can only exist with support from the government would no longer exist (through the process of elimination that parallels the theory of natural selection put forward by Darwin).  This also means that he does not support the idea of a welfare state (eg. Canada) but a program of “guaranteed income” instead.

These notions are not limited to the economy but to all of the facets of society – education for example.  Friedman believes that parents should be given tuition vouchers by the government to pay for their children’s education.  Because they are able to choose which schools their children will attend, and because money would no longer be an issue in terms of enrollment, only the best schools would survive.  In other words, schools which did not provide a satisfactory level of education and a positive environment would cease to exist because parents would send their children to other schools instead.

Friedman belongs to a school of thought known as monetarism.  Monetarists stress the importance of the amount of money allowed to circulate in a given economy as an instrument of government policy and as a determinant of business cycles and inflation.  According to Friedman, governments should raise the money supply by a fixed amount each year…Too much money in circulation causes inflation; too little money reduces investment and employment levels.

The Contemporary Scene

Can the problems of economy ever be solved?  It seems that every time we try to solve one problem, that solution creates a new problem.  Whenever we reach a goal, we seem to move further away from another goal.  Additionally, the same problems that were thought to be solved also seem to reappear later on and manifest themselves in an even more problematic fashion.  This chapter begins and ends with the notion or idea of laissez-fair.  Does this make sense?  The idea which has advanced economic thought in the late 20^th century/ early 21^st century is the exact same idea that furthered economics in the late 1700s?!?  It seems so.  But what does it all mean?  It means that clearly Some economic goals conflict with one another, and some theories need to be rethought in light of changing times (page 67).  Society is a living thing… it is dynamic and as such, the theories which govern the evolution of economic thought and political economic policies must change with those times. 

Beyond the theories, we must also consider the theorists.  In the past, Economics (like so many other disciplines) has been primarily male-dominated (DWEMs – Dead White English Males).  This basically means that theories which promoted the evolution of economics in the past have been based on only half of the intellectual power/resources available to us.  Examining this from an economic standpoint, we can understand that if the possibilities for economic evolution were graphed, we have never reached the frontier of our production possibilities curve!!! J  Recent times, with the suffragists movement in Canada and the US (and indeed, the world) have yielded some very powerful female intellectuals in the area of economics.  Some Canadian women who have contributed to the evolution of economic thought are: “Nuala Beck, Dian Cohen, Sherry Cooper, Judith Maxwell, and Sylvia Ostry” (page 66).

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UNIT 2

Chapter 4

Market: A market is a place for commerce; a network of buyers or sellers. Also the demand for a product; a price determination process

 Demand: The quantity of a product that buyers will purchase at various prices during a given period of time.

 Law of demand: A law stating that the quantity demanded of a product varies inversely with price, as long as other things do not change.

Demand schedule: This is a numerical tabulation, usually organized into a table, of the quantities demanded at selected price. 

Demand curve: A straight lie or curve on a graph illustrating the demand schedule for a product.

 Market Demand schedule: The sum total of all the consumer demands for a good or service.

 Supply: The quantities that sellers will offer for sale at various prices during a given period of time.

 Law of supply: A law stating that the quantity supplied of a product will increase if price increases and fall if price falls, as long as other things do not change.

 Supply schedule: a table showing that quantities of a product supplied at particular prices.

The term market has four distinct, but related, meanings, none of which coincide with the definition of economy.

 ·        A market can be physical place where a product is bought and sold. Market in this context can range from the corner convenience store to the Toronto stock exchange.

 ·        The term market can also be used in a collective sense to refer to all buyers and sellers of a particular good or service.

·        A market can be the demand that exist for a particular product or service. For example the newspaper may describe the market for cars as being sluggish.

 ·        The term market can also describe the process by which a buyer or seller arrive at a mutually acceptable price and quantity.

An economy includes all these and more. 

The market itself determines the price of a good or service.  This involves matching the buyers and sellers of a particular product or service. Buyers, for the most part, want the price to be as low as possible, while sellers want the opposite. Often they agree on a price that is somewhere in the middle.

 There are two things that cause the rise and fall of prices. They are demand and supply.

 Whether or not a person has a demand for a product depends on two actors. One is located in your head or heart, and the other is in your wallet. Basically demands exist only for the things that you want and can afford to by. If you have the desire and the money to pay for a particular thong than you are said to have a demand for that product. 

Consumers tend to buy more of a product if the price is low. There are two reasons for this. They are: the substitution effect and the income effect. 

For example, if the price of a particular product rises we tend to buy another product that is similar, with a lower price. This is known as the substitution effect.

The second reason involves income. For example, if the price of name soda falls from $5 to $4 a case, buyers can buy the same amount of soda for a lower price. The money that they save actually represents $1 in extra income.

 The relationship between price and the quantity of a particular product is known as the demand schedule.  This is usually represented in a table (represented by for example price of t-shirts, $20, to the quantity demanded, 4.

 There is major difference between quantity demanded and demand. The quantity demanded refers to one relationship that is determined by price. The demand for a particular product is represented by the entire schedule of price. 

On a graph the price is measured by the vertical axis, while the quantity demanded is measured on the horizontal axis. Ones the points are plotted on this graph and joined together; it then becomes the demand curve. Although it is a demand curve, it can also be a straight line. 

We can get a better idea of the relationship between quantity supplied and price by examining the supply schedule. The curve on this graph is quit different from that of the relationship between price and quantity demanded. On this graph (price to quantity supplied), the line goes from the bottom left corner to the top right. This demonstrates that supplies supply less at lower prices and steadily increase the quantity supplied as prices increase. 

The terms supply and quantity supplied, are quite different. The term supply refers to the whole series of price and quantity relationships. Quantity supplied refers to one relationship that is determined by price. 

Market Equilibrium 

• In the real world, the prices consumers pay and sellers receive are determined by the interaction of demand and supply. (Page 78)

 ·        When the price of a product is too low, the quantity demanded will be too much, and there will be a shortage.  The seller will then increase prices to control this shortage.  The problem is how much should it be raised?

·        The goal of any seller is to reach an equilibrium price so there will be neither a shortage nor a surplus.  Market equilibrium is a point at which the demand of the consumers meets the supply by the sellers, forming an equilibrium price.

A Demand and Supply Graph 

• Demand and supply graphs can be combined to form one graph. (Figure 4.9a, Page 78)
  
  

• The point at which the demand and supply curves meet is called an equilibrium point.  The price at this point is the equilibrium price, and the supply is the equilibrium quantity.
  
  

• The price above the equilibrium point is the surplus value.  This represents an amount of product that is not demanded by consumers but is supplied by sellers.  At that price, both the demand and supply are above the equilibrium price.  This means that fewer consumers are willing to pay that amount for the product, so the supply is too great, creating a surplus. (Figure 4.9b, Page 79)
  
  
  

• The price below the equilibrium point is the shortage.  This represents an amount of product that is demanded by consumers but is not supplied by sellers.  This means that more consumers are willing to pay that amount for the product, so the supply is too small, creating a shortage. (Figure 4.9c, Page 79)
   

Changes in Demand and Supply

·        There are other things that affect the demand and supply of a product, the non-price factors.  Up to this point, we have held all of these factors constant while making supply and demand curves.  We only took into account changes due to price.

·        Non-price factors cause changes not along the curve, like price, but instead cause the entire curve to move up and right, or down and left.  This is because the demand or supply has been affected, not the quantity demanded or supplied.  In order to understand this, you must first understand the difference between demand and quantity demanded (page 75), and supply and quantity supplied (page 77).

 

Changes in Demand

• Five basic things can happen in any economy to change the demand.  They include, income, population, tastes and preferences, expectations, and price of substitute goods.  They can each cause an increase in demand, therefore a shift in the demand curve. (Figure 12, page 81)
  
  

  Income

• When an increase in income occurs for a potential buyer, that person’s buying power goes up.  This could result in an increase in demand of a product.  This generates a shift in the demand curve up and to the right, which increase the equilibrium price. 

• If a person’s income dropped, the opposite occurs, causing a shift in the line to the left, and a decrease in the equilibrium price.

Population

• An increase in the number of consumers could mean an increase in demand for a product.  This would cause a shift in the demand curve and the equilibrium price the same as in income. 

• A decrease in the number of consumers would have the opposite affect, same as the decrease in income did.

• In order for sellers to know if the demand for their product decrease or increases, they study demographics.  Demographics are population statistics that show changes in age, income, and overall numbers.

Tastes and Preferences

·        When consumers change what they like, it can cause an increase in demand for certain products, while causing a decrease in demand of another.  An increase in demand would cause a shift up and right on the demand curve, and increase the equilibrium price.  A decrease in demand will do the opposite.

·        This is because of consumer sovereignty, the principle that consumers decide what is bought and sold.  When consumers change, products change to fit the new wants and demands.  By switching, sellers create a new, increased demand for their products.

·        Also, a good advertising campaign can increase or decrease demand for a product, depending on whether it is successful and if people like it or not.

·        Similarly, because of medical research, low fat foods have an increasing demand, whereas greasy fast food has a decreasing demand.  Hence the reason McDonald’s now has a “lighter choices” menu.

Expectations

• Consumer expectations are what consumers believe will happen to the price of a product in the future.  Such beliefs have an effect of changing consumer demand for the product at present.

• If consumers expect the price to increase, they will rush out and buy it, cause an increase in demand now and a shift up and to the right in the demand curve.  However this causes a decrease in demand later, having the opposite affect.

• If consumers expect the price to drop, they will wait to buy it and cause a decrease in demand now and a shift to the left in the demand curve.  This will in turn cause an increase later, and have the opposite affect on the demand curve.

Prices of Substitute Goods

• Substitute goods are goods that are similar to other goods and serve as an alternative if the price of the usual good increase.  So, if the good a consumer usually buys increases its price, the consumer may switch to a substitute good, causing a decrease in demand of the original good.  This cause a shift in the demand curve to the left. 

• However, if the substitute good increase its price, and is only slightly less expensive than the original good, many people will opt that the price difference is not worth the decrease in quality.  This will reverse the affect of consumers switching to substitute goods, and push the demand line right.

Complement goods are items sold together with other goods.  For example, cars and gas are compliment goods, if you buy a car, you need to purchase gas to drive it.  A fall in price of one complement good will increase the demand for the other.

Changes in Supply           

            Different factors can cause a shift of the whole supply curve. There are five major factors that if any change occurs will cause the supply curve to move to the right, (indicates an increase in supply), or to the left (indicates an decrease in supply). These factors are: 

J                 Cost

J                 Number of sellers

J                 Technology

J                 Nature and the environment

J                 Prices of related outputs

Cost 

            The increasing or decreasing in production cost will affect the quantities that sellers are willing to supply because a change in cost in affects profits. If there is a decrease in production cost than more of that product will be supplied. However, an increase in production cost will mean a decrease in how much of that product will be supplied. If there is an increase in production cost than there is a decrease in supply, but if there is a decrease in production cost than there is an increase in supply.

Number of sellers 

            The amount of sellers has an effect on a market. If there is a decline in sellers and the remaining sellers does not increase their supply, than the quantities supplied in any given price will decrease. This will shift the supply curve to the left. In addition, if the number of sellers increases than the quantity supplied at any given price will increase thus moving the curve to the right.

Technology 

            An improvement in technology will decrease the cost of production thus enabling manufactures to increase the supply of a product at any given price thereby shifting the curve to the right.

Nature and the environment 

            A simple change in weather can have an affect on supplies of a certain product. If a drought occurred for instance, than the supply in farmers crops would decline. An example in Newfoundland would be the Atlantic cod. Due to environmental disasters, the cod stock decreased so supply decreased, and price increased. This shifted the supply curve to the left.

Prices of related outputs 

            If there is a more of a demand for another product than manufactures may switch to supplying that other product thereby decreasing the supply of the first product at any given price, shifting the supply curve of the first product to the left.

Perfect (pure) Competition: a rare market structure characterized by many sellers (selling exactly the same product) and many buyers, no barriers to entry into the market for new firms, and perfect knowledge of prices (so there are no price differences and no individual can influence them).

The Determination of Price (Pg.88)

A competitive market is one that contains all of the characteristics below:

• It has many producers/sellers and no one firm/company is big enough to dominate the entire market

• It has many buyers with no one buyer large enough to dictate price to sellers (control it)

• Each seller/producer is producing the exact same product so no one company can raise there prices because their product is of better quality (because it is not)

• All of the buyers and sellers know what the prices and conditions are throughout the market so the possibility of price differences if eliminated

• This type of market is also called a pure or perfect competition market. In today’s economy, it is very hard to find an economy that has each of these characteristics. Nevertheless, pure competition is an ideal or a model that economists use to compare and evaluate real markets for the products bought and sold in Canada, and of course in other countries as well.

The Coffee Market in Canada (Pg.88-90)

            The below is an example of a market that comes as close to the ideal pure competition market than any other (the coffee market in Canada) and in this example you will find what effects changes in demand and supply, along with their shifting curves, have and equilibrium prices (cause them to rise and fall)

• An increase in demand will have the following effect:

Basically, if you have retailers buying coffee beans at $8/kg and suddenly the demand for the coffee goes up (in the book it says how in the 1990s the demand for coffee went up as coffee houses were now used more for social places) then there will now be a shortage of coffee. Seeing as how the demand for the coffee is now higher then the price of the coffee must also be raised in order for their to be an equilibrium price (which would now be $10/kg)—see page 89 for more information and to see a graph of a similar situation (figure 4.18a) 

• A decrease in demand will have the following effect:

Basically, if the demand for the coffee decreases then the exact opposite will occur. If the retailers are buying the coffee for $6/kg and the demand falls, then there is now a surplus of coffee beans. As a result, the equilibrium price (price at which consumers are willing to buy and price at which retailers are willing to sell) will have to fall in order to try and compensate. The new equilibrium price will now be $4—see page 89 for more information and to see a graph of a similar situation (figure 4.18b) 

• An increase in supply will have the following effect:

Basically, if the supply of coffee were to increase then there would now be a surplus of coffee. As a result, the price of the coffee will go down from $6 to $4 and in turn, eventually creating a higher demand. This movement shifts the supply curve to the right (and down) also the surplus is eliminated. The new equilibrium price will now be $4—se page 90 for more information and to see a graph of a similar situation (figure 4.18c) 

• A decrease in supply will have the following effect:

Basically, if the supply of coffee were to decrease, then the original demand will be more than the current supply and thus there would be a shortage. This will cause the price to rise from the original $6 to $8. The supply curve moves up (and to the left). The new equilibrium price and quantity demanded would eliminate the shortage (the price goes up and the demand goes down)—see page 90 for more information and a graph of a similar situation (figure 4.19c)

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Chapter 5

Elasticity of Demand

 Elasticity: the responsiveness of quantities demanded and supplied to changes in price

 When prices fall or rise how much more or how much less of a product consumers will buy can be determined by a formula developed by economists.  This formula measures the actual change in quantity demanded for a product whose price has changed.  This is known as the price elasticity of demand.  Formula can be found on page 95 along with example. 

 The effect of the change is the numeration (people buying more or less) and the cause is the denominator (the change in price that affects people’s buying decisions).

 There are 3 coefficients of demand

 Inelastic Coefficient is any coefficient between zero and one.

Elastic Coefficient is any coefficient greater then one

Unitary coefficient is a coefficient that is equal to one. 

See Figure 5.2 Page 97

 Total revenues: the price of a product multiplied by the quantity demanded.

 To find the coefficient of demand one must find the total revenues.  Ex. P. 96 Figure 5.1

 There are four factors that can have a strong effect on demand elasticity.  They include

 Availability of substitutes:  Goods that have substitutes tend to be more elastic then goods that do not.  This means that when price rises total revenues fall and vise versa.  This is because of the large variety involved with this product.  If there was not a large variety of the product then the product would be inelastic. 

 Nature of the Item:  Goods that are necessities tend to be more inelastic then goods that are considered to be luxuries.  This means that when price rises total revenues rise because no matter what the product is needed.  There are no substitutes.

 Fraction of income spent on the item:  Goods that are expensive and therefore take up a large part of household budget will be elastic.  This means that as price rises total revenues fall and vise versa.  This is because people do not want to spend large amounts of money on one item and will therefore look for substitutes bringing us back to availability of substitutes.

 Amount of time available:  The more time consumers have to look for substitutes the more elastic a product becomes.  People will try to find the lowest price so as price falls total revenues rise and vise versa.  However, in the short run consumers may not know what substitutes are available therefore making a product inelastic.    

Elasticity of supply: this concept measures how responsive the quantity supplied by a seller is to rise or fall in price.

 The concept of elasticity also applies to the suppliers, or the sellers’ side of the market.

 The formula to determine the coefficient of supply is as follows:

(To get a better understanding look at the example on page 98 of the Economic text)

 ·        Any supply coefficient that equals out to be less than one is classified as inelastic, equal to one is unitary, and more than one is elastic.

 ·        A seller with an elastic supply is better positioned to take advantage of an increase in demand for a certain product.

 ·        Quantity supplied can easily and quickly be increased to meet demand, resulting in an increase in revenues

 ·        Once the supply coefficient becomes less than one, the seller cannot increase the quantity supplied by a greater percentage increase in quantity supplied.

 ·        A price range that has a unitary supply elasticity has a coefficient that is equal to one. In this case the seller is just able to match a price increase by the same percentage increase in quantity supplied.

Factors affecting supply Elasticity

 There are three factors that can have a strong affect on supply elasticity. These factors are: Time, Ease of storage and Cost factors.

 Time 

·        The longer the time period a seller has to increase production, the more elastic the supply will be.

 ·        Economists say that in the long short term, supply is inelastic, and in the long term, it is elastic.

 Ease of storage

·        When the price of a particular product drops, sellers have two options. They can either sell the product for a new low price, or they can put some of their inventory into storage and sell it after the price rises again.

 Costs factors

·        An increasing output (supply) may be costly depending on the particular industry.

 Supply is more elastic in industries that have lower input expenses

Marketing Consumption Choices: Utility Theory

The rational way of explaining our buying and consuming decisions was first theorized by Alfred Marshall.

It is known as the marginal utility theory of consumer choice, or utility theory for short.

The marginal utility theory of consumer choice states that the extra satisfaction that a consumer achieves from continuously consuming the same good diminishes.

Marginal utility is the extra satisfaction a person receives for consuming the same product continuously.

Total Utility is the total satisfaction gained from consuming the same product continuously. It is the total amount of all marginal utility.

Utils are units of satisfaction.

Let’s use soft cola for an example. If Johnny buys a bottle of cola on Monday, his marginal utility will be 12 His total utility will also be 12, because that is the total satisfaction so far. Is he buys another bottle on Tuesday, his marginal utility will be 8, and his total utility will be 20 (the total of both his satisfaction of 12 and 8). If Johnny buys a third bottle of cola on Wednesday, his marginal utility will be 4, and his total utility will be 24 (the total of all his extra satisfaction). This will continue until Johnny’s marginal utility is 0. He will get sick of drinking cola, therefore his extra satisfaction stops.

This shows us that as amount consumed increases, the marginal utility decreases. It varies inversely with amount. This example also shows us that total utility has a direct relationship with amount consumed. The more you buy, the higher the total utility is.

This method can be used to determine which out of a variety of products would get you the most satisfaction.

Figure 5.10 on page 102 shows another example of the utility theory.

When a consumer is purchasing more than one item, a problem of which combination gets the most satisfaction arises. In order to get the most satisfaction for a certain amount of money there is a formula economists use. Marginal Utility/price of product A = Marginal Utility/price of product B.

Let’s go back to Johnny. Let’s say he also wanted to buy potato chips. To make things easier, let’s say that both his marginal and therefore his total utility is the same as for cola. In our example, the price of cola is $2, and the price of chips is $1. Johnny’s budget is $7. If you worked out each value, you would see that a combination of 2 bottles of colas and 3 bags of chips would be equal for his budget of $7, giving Johnny his maximum satisfaction.

8/$2=4/$1

                    4 = 4

Two colas at $2, is $4, and three chips at $1, is $3. This gives a total of $7.

This is known as the consumer equilibrium, the maximum satisfaction a costumer can reach for a certain price, when the marginal utility over price fr two products is equal.

Figure 5.12 on page 104 shows an example of this.

We can relate the utility theory to the demand curve, Adam Smith’s paradox, and consumer surplus.

The Demand Curve

The theory of marginal utility follows the downward slope from top left to bottom right of the demand curve.

As people consume more, their extra satisfaction declines. If they get less and less satisfaction out of it, then they will want to pay less for the product.

Adam Smith’s Paradox

His paradox of value, asks the question, why are the things we need to live by less expensive than the items that we don’t need. For example water is much less expensive than diamonds?

To answer this question, we must look at the total and marginal utility of both products. The total utility for water is very high, but the marginal utility is rather low. We drink water all of the time. The opposite is true for diamonds. The satisfaction from buying one is extremely high.

Consumer Surplus

Consumer surplus is the difference between what a consumer is willing to pay for a product compared to what s/he actually pays. In order to demonstrate this, lets look again at the price of cola in one month. If the price for a case of cola was $10, Johnny would be willing to buy one case. If the price was $8, Johnny would be willing to buy a second case. If the price of a case is $6, he is willing to buy a third case. Let’s assume the price for a case of cola is steady at $6 for that month. Johnny would be willing to pay a total of $24 for his three cases of cola. However, because the price is steady at $6, he only pays $18, saving $6. This $6 is his consumer surplus.

Figure 5.13 and 5.14 on page 105 give another example of consumer surplus.

Economics Now

Chapter 5

Joshua Flynn

Government Intervention in Markets

            The market engines of demand and supply produce the goods and services that consumers wanted. Then the goods and services are distributed with a minimum of waste and shortage. There is no benefit for the individuals and groups that provide direction for the economy.

Governments do intervene in markets. Three examples of controversial government actions:

1. If the government believes that people are paying too much for an item than it will introduce a ceiling price as a solution.

2. If the government believes that sellers are making too low of a profit than it will introduce a floor price as a solution.

3. If the government believes that it must interfere in a market for social or environmental reasons, it will introduce a subsidy or a quota as a solution.

Ceiling Prices

            A ceiling price is a price in which is set by the government to prevent the price of a product from rising above a certain level. If the ceiling price is set below the equilibrium price than there will be a resulting shortage. To find the shortage just subtract the quantity supplied from the quantity demanded and the answer will be the shortage.

            There are three possible outcomes of price ceilings:

1. Shortage can cause long line ups for the product

2. May create a black market for a certain good-happens when a shortage of a product encourages some people to stock up on that product and to sell it to others who can’t get enough of it for their own personal use for a higher price

3. May cause quality of a product to drop if sellers try to reduce their cost in order to make more money

Black Market: the illegal exchange of goods in short supply, as when some people buy up as much of a good as possible, stockpile it, and sell it at a higher price.

Floor Prices

            A floor price is a price in which is set by the government to prevent the price of a product from dropping below a certain level. If the floor price is set above the equilibrium price than there will be a resulting surplus. To find the surplus of just subtract the quantity demanded from the quantity supplied and the answer will be the surplus.

            Maintaining floor prices creates two problems:

1. There is a problem to do with the surplus

2. Consumers pay a higher price for the product and receive less

Subsidies and Quotas

            Both price ceilings and price floor share a common problem: less of a product is bought and sold when the price is forced away from the equilibrium price by these policies. The government sometimes enacts subsidies to avoid this problem. A subsidy is a grant of money made to a particular industry by the government.

            A subsidy allows consumers to pay lower prices and allows sellers to gain extra revenues. It also creates more of a product to be bought and sold or transacted between the buyer and seller. However, money has to come from somewhere for the government to give grants-taxes.

            Quota is another way to help producers. A quota is a restriction placed on the amount of a product that individual producers are allowed to produce. These restrictions are managed by marketing board, which is made up of representatives from the government and the producers. One example is farmers. The government believed that farmer’s income was too low so a marketing board was established. If the farmers went out of business than Canada’s people would have to pay more for their food.

Rent Controls

            A rent control is an example of a ceiling price. Rent is the price people pay for accommodation and is determined by demand and supply. Usually the supply line is vertical because owners cannot increase supply of apartments immediately. The supply of apartments is fixed, or perfectly inelastic in the short run.

            An increase in demand for apartments increases the rent. This has two effects: those who can afford the high rent will stay and pay while others who cannot will not be able to stay and pay so they have to search for apartments with lower rents.

            High rents mean high profits, which means more apartments. When there are more apartments than the rent falls. However, if the government was to set a rent control, than a shortage in apartments will occur because the owner cannot afford to build more apartments, so people find it difficult to find a good apartment. The only way to build more apartments is for them to stop making repairs on the old ones.

Minimum Wages

             Rent control is an example of how governments establish ceiling prices. A wage is the price a worker receives for supplying labor to a business with a demand for it. A minimum wage is set by the government to raise low wages of workers higher than the one set by demand and supply.

            The problem with this is unemployment. If the minimum wages are raised than the company can only afford to hire fewer workers there by putting others out of work. Minimum wages create surpluses of potential workers who cannot find jobs. However, many who are employed have higher wages. 

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Chapter 6

Types of Industrial Activity Pages 120-121

High-tech (industries): Industries that develop, provide, or use highly complex technology

Staple: Products requiring little processing such as fish, fur, lumber; Canada’s main exports from the 16^th to the 18^th centuries

**Goods-producing industries = primary and secondary industries

    Services-producing industries = tertiary and quaternary industries

**All human industrial activity can be classified into one of four types (primary, secondary, tertiary, or quaternary)

**Basically, if the industry deals with the harvesting of raw materials (with very little processing/refinement—catching cod, forestry, mining, etc…--resource extraction) then it is a primary industry, if it includes the processing of these raw materials into a finished/semi-finished product then it is a secondary industry (eg. Paper mills, cod processing plants, etc…), and if the industry deals with services such as whole sale, retail, research and development then it is in the service area (and either a tertiary or quaternary industry/sector)—see figure 6.1 page 120

**Quaternary activities consist of high-tech services provided to people, firms, and institutions. Was once considered to be a part of the tertiary industry. As high-tech services began to grow and expand, a special category was created just for them. This industry is a fairly expensive one so it is still fairly limited in terms of the grand scheme of the world (many countries are not developed enough to be able to handle this industry)

The Historical Development of Canadian History

**The development of the economy traditionally is a linear progression, which means it (the economy/industries) first starts off with a primary sector, then creates a secondary sector to refine the raw materials, then a tertiary industry to basically sell these goods, and finally a quaternary or high-tech service industry (see figure 6.2 page 121)

Primary Industries

**Canada’s economy first emerged and grew in response to the demands held by urbanized European communities for Canadian natural resources. During 16^th-18^th century, fish, fur, and lumber were the main export staples, which gave the economy its largest part of the income. These resources attracted labour and capital from Great Britain and France and as a result, the primary industries were the first industries in Canada. Fur, fish, and lumber could be sold in a European market for gold and silver so the British and the French carefully controlled the expansion of the industry. Eventually as settlements moved westward, wheat, iron, nickel, etc… were added to the list of exports from Canada. This also attracted more labour and capital. Seeing as how some of the goods were now being produced locally meant that Canadians could by some goods a lot cheaper than they could before they produced it themselves.

Secondary Industries

            With the industrial revolution in the 1780-1850, came more effective, efficient, and cheaper ways to extract and process goods. Also, the development of steam powered trains and ships helped to further free trade between countries (more countries could be reached because of train/ship). More labour and capital was focused more on the processing of raw materials (secondary industry) than the extracting of the raw materials.

            Later on, around 1879, coal powered generators and hydroelectric generators were developed as inexpensive power sources for machinery used in the making of consumer gods in large quantities. As the technology improved, fewer workers were needed to produce manufactured goods.

Service Industries

            The surplus of workers created by advancements in production machinery for manufactured goods created/encouraged a shift of labour and capital from export staple production to specialized services (transportation, warehousing, financing, health care, etc…). By the middle of the 20^th century, Canada had become an industrial nation and had achieved a balanced economy of primary, secondary, and tertiary sectors.

**Prosperity and growth depended on finding markets for its export goods

**The development of a large service industry in any economy depends mainly on a good-producing industry(ies) that establish a strong export base and thus a steady flow of money into the economy

**Employment shifted towards service during the economic boom after WWII, and continues to the present day. In Canada in the past 25 years, the level of service specialization has increased as it has developed its quaternary industries. Canada is now major exporter of fibre optic technology, nuclear power generation technology, etc…

Forms of Business organization

Firms are units of ownership engaged in business activities. They are designed to achieve maximum profits for a product that consumers are willing to pay for. 

There are five different types of businesses:

A sole proprietorship is a business owned and operated by one person.  Although owners may hire other people to work for them they are responsible for the firms debts and are entitled to all the profits.

Advantages and disadvantages

• Owners are their own boss and therefore get to make all the decisions. 

• All important information can be kept confidential.

• The biggest disadvantage is unlimited personal liability of the owner. This means that the owner’s personal things can be taken to pay off the business debts.

• Were there is only one owner the owner has no one else to rely on for money.

• The income tax is progressive meaning the more money one earns the more income tax one has to pay.

See p. 123 for more information 

A partnership is a firm owned by two or more people.  Each partner must sign a partnership agreement, which outlines his or her rights and obligations and can establish either a general or limited partnership. 

 A general partnership is where all members take part in the management of the business and everyone has unlimited personal liability, meaning that if the business goes bankrupt then some of every partners personal assets can be taken. 

 A limited partnership is where partners are not apart of the management process, so therefore if the business has financial problems only the amount of money that the limited partner invested in to the business can be taken from him or her. 

 Advantages and disadvantages of a partnership

  §         In a partnership all of the different characteristics and knowledge that the partners have are put together. 

§         People do not have to take business risks by themselves.

§         Partners share all profits made.

§         Personal assets can be ceased if the business runs into some financial problems. 

§         Since all general partners have some say in how the business is run some disputes may occur, and thus often partnerships do not last a long time.

See p. 124 for more information

 A corporation is a business firm legally recognized as a separate entity in its own. This means that the income tax paid to the government is separate to that of its owner. 

 Corporation assets are divided into equal parts called shares.  The owners of these shares are known as shareholders.  There are two different types of ownership shares that are offered to investors:

 Common shares allow the shareholder to have voting rights and therefore give them some say in how the business is run.  Preferred shares allow people to receive part of the profits earned but they have no voting rights. 

 Advantages and disadvantages of corporations

 §         Where corporations are so big they no longer need loans to finance them.

§         Owners can only lose as much money as they invested into the corporation if it happens to go bankrupt.

§         There are fewer risks in investing in a corporation. 

§         Corporations usually pay lower income tax rates.

§         Governmental fees for establishing a corporation is higher then those of a proprietorship and partnership. 

§         They are closely regulated by the government.

See p. 125 for more information.

 A co-operative is a business firm owned equally by its various members.  Each member has one vote and the majority usually wins.  

There are four types of co-operatives:

 Retail co-operatives: provide goods and services to members at reduced prices.

 Marketing co-operatives: sell the product to members for the lowest price possible.

 Financial co-operatives: arrange savings and loans with better rates then those at local banks.

 Service co-operatives:  provide special services.

 Advantages and disadvantages of a co-operative enterprise 

• Each member has equal say in all management decisions.

• Any money made is paid out to the members in the form of patronage returns.

• Where each member has equal say it can cause problems.

• They are restricted to conducting business with existing members.

See page 126 for more information

The Government Enterprise

Government enterprises are businesses that are owned by the government.  They provide services that a private sector will not because the profits are too low.  The government may set up these enterprises to increase competition or to increase employment rates in a specific area.  

Crown corporations are businesses that are owned by the government but work like other corporations.  However the government itself owns most of the ownership shares.

Government enterprise is supposed to operate in the best interests of the community rather then to generate profits for shareholders.  The government usually covers operation expenses and business losses through grants, subsidies, or annual operation budgets. P. 127

Non-profit and charitable organizations

These are institutions that do not operate to generate profits.  A board of directors, which include both hired staff and volunteers, manages these enterprises.  Many of these organizations try to raise money for people in undeveloped countries.  

Horizontal integration: The merging of two firms that produce the same product or service.

Research and Development: A process of investigating, experimenting, and developing new products, technology, and production methods carried out by universities, governments, and businesses.  

 Horizontal merger: A consolidation (combining) of two firms producing the same product or service.

 Vertical integration: The merging of two firms involved in different stages of the production process of a good or service.

 Corporate Alliance: A group of companies that agree to operate as a single company while retaining separate ownership.

 Holding Companies: An enterprise that holds shares in other producing companies.

 Conglomerate: A group of companies involved in different industries, but controlled by a central management group.

 Subsidiaries: A branch plant of a multinational corporation.

 Multinational corporations: A firm that operates in more than one county; a corporation with a global production and selling strategy, having had quarters in one country and branch plants in several other countries. 

Branch plant economy: A somewhat censorious term applied to Canada in the past, referring to the numerous branch plants of foreign multinationals operating here, particularly US ones. 

Brain drain: Emigration of Canadians talented in research and management to the US and other countries.

Small and Big Businesses

-         Small businesses, by virtue of their numbers, constitute the engine that fuels the Canadian econom

 -         Big businesses employ thousands of Canadians and have a great deal of political influence  

              -         Businesses are said to be the wheels that steer the economy in a given direction  The Canadian Federation of Independent Business       (CFIB) classifies a business by the number of employees it employs.

              -         Small business includes all the independently owned firms with fewer than 50 employees

 -         Medium-sized business includes all the independently owned firms with between 50 and 499 employees

             -         Big business includes all the independently owned firms employing 500 workers or more

Small Businesses (fewer than 50 employees)

-         Small businesses are generally limited in the size and scope of there operations 

-         They face intense competition from other small firms 

-         Many small businesses maintain their competitive advantage by limiting their operations to one specialized field or process (for example garage may only repair automobiles) 

-         Since they are small and focused on one area of specialization, these firms are usually very sensitive to changed in the market place

Big Businesses- Horizontal integration (500 or more employees)

-         Smaller firms often grow lager through the process of Horizontal integration    

-         By increasing the size and the efficiency of operations, these larger Canadian firms may compete more effectively on a global scale 

-         By increasing the size, Horizontal merger, it will give the larger enterprise better access to both domestic and foreign markets (read example on page 130 about the merge between Chrysler and Daimler- Benz)

Vertical integration

-         Vertical integration can diversify and extend the scope of a firms operation by helping it to establish ready markets 

-         Big businesses benefit from Economics of scale (Economics of scale refers to the greater efficiency that some firms can achieve when they produce a very large amount of output) 

-         Big businesses can acquire the latest technology by purchasing control of smaller businesses. They can assume larger risks than that of a small company

Corporate alliance

-         Firms can choose to collaborate on specific projects with competitors or suppliers. This enables the firms to bring in a larger profit

 -         (Read the example under the Corporate alliance section to get a better under standing)

Multinational Corporations in the Global Economy

-         As part of the natural growth and expansion, many firms sell a portion of their outputs abroad. License foreign companies to use their manufacturing processes or even establish their own branch plants

 -         Once several countries are involved, the company’s mangers begin to base their financial, production, and marketing decisions on global concerns.

             -         Firms large enough to operate from this standpoint are known as Multinational Corporations

             -         Corporations prefer to operate as multinationals because it will improve their profitability 

-         These foreign branch plants provide free access to new markets 

-         Decision making for multinationals enterprises are very complex (read section)          

Financing Corporate Expansion

• The majority of businesses in Canada are corporations.  They can raise their capital goods by selling bonds and additional ownership shares.

Different forms of Securities

• Bonds are financial assets that represent a debt owed by a corporation to the bond holder, on which interest is paid by the corporation.  Basically, this means that you by a company bond for, let’s say five hundred dollars, and freeze it for ten years.  The company will give you ten dollars interest, for example, every six months.  After ten years, you get the original five hundred dollars back, called the principal.

• Usually, the longer the loan the higher the interest rate, and competition plays a large role in the amount.   

• The bondholder has no part in owning the business, therefore has no say in decision making, s/he is just a creditor.

• Corporations also raise capital funds by selling shares.  This means that there are additional owners in the corporation, therefore more money.

• Asset value is each share’s portion of the corporation’s net worth, or how much money each share holder owns, you could say.

• Book Value is the first issued price of the share, how much the share should cost.  It is what the price ideally should be. 

• However, it is possible that the stockholder will not get the asset value or the book value for the share.  The market value is the actual price of the share.

Securities Markets and Trading

• Shares can be bought or sold, traded, in a stock market.
  
  

• A stock exchange is a physical place where the trading of stocks occurs, like the Toronto Stock Exchange (TSX), for example.
  
  

• The National Association of Securities Dealers Automated Quotation (Nasdaq) has become one of the largest stock markets in the world. It has no central location, trading is done between brokers, acting on behalf of customers, and Nasdaq brokers, called market makers

• A stockbroker is a person who trades stocks for clients.

• Supply, the amount of shares offered for sale, and demand, the amount of shares consumers want, cause fluctuation in a companies stock.

• Mutaul funds are a more passive type of trading stocks.  People who own them do not deal with the ups and downs of the market, they hire professionals to do it. 
  
  

Commodities Market

• Commodities are standardized raw or semi-processes goods resulting from primary industrial activity, that are traded at a commodities market in bulk.
  
  

• Commodities markets include both spot markets, where goods and services are traded immediately, and futures markets, where prices are agreed upon in advance.  Futures markets usually deal with the trading of future contracts, or options, because most investors don’t intend on receiving the actual product. 
  
  

• A call option is the right but not the obligation of the buyer to purchase the good at the pre-arranged price and time.  A put option is the seller’s right but not the obligation to sell the good at the pre-arranged price and time.  However, both parties usually pay a percentage of the market value of the contract to the commodities market.
  
  

• Sometimes, the contract price is higher or lower than the market price on the contract maturity date.  In this case, one party must pay the other party the difference.  If the contract price is higher than the market value, the buyer ends up with more, but if the contract price is higher than the market value, the buyer must give the seller additional funds.

Understanding Stock Market Indicators

·        The Dow Jones Industrial Average is the most popular indicator of stock market trends.  It is calculated from day to day, based on blue-chip closing prices.  Blue-chip are safe and stable stocks, they are almost one hundred percent predictable.

·        In Canada, the leading stock market indicator used to be the TSE 300, where three hundred stocks where divided among 14 companies that represented the Canadian economy.  Each company was given a weighting based on their number of shares.  It was believed that the events in the TSX would mirror what happened to the TSE 300.

·        The S&P/TSX Composite index is now used in Canada.  This uses company size and trading activity to make an accurate comparison of the index in Canada to those around the world.

·        A Bear Market is a stock market under the influence of traders who expect prices to fall.  A Bull Market is influenced by traders who expect process to rise.

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Chapter 7

How to Produce

• Function of any economic system is to provide goods and services to satisfy wants and needs

• Canada’s government owns productive economic resources (such as crown land), rights to natural resources and public infrastructure like roads and public buildings

• The three levels of government (federal, provincial, and municipal) provide goods and services

• The Canadian economy is a market economy

• Private companies are significant to the sales of goods and services in Canada

• Canadian government provides services funded by taxes but if taxes are too high people can elect a new government that will lower taxes

• The Prime Minister does not tell people what they will do, what goods and services they will produce and the price they can offer

• Canada does have a monarch (supreme governor, ex. Queen Victoria) but the power she has is only symbolic

• Real Gross Domestic Product is the total value of goods and services produced by the Canadian government in a year

• GDP is also what the government produces, which is determined by how much the government spends in a year which is called government expenditure (see page141, figure 7.1)

• Commercial enterprises make up the private sector

• In a market economy private firms make a large amount of the basic economic question, How to Produce?

• Private firms largely determine how scare economic resources will be developed and used to meet Canada’s needs

Origins of the Firm

• Once humans were self-sufficient or independent but humans eventually started trading

• The invention of money was a necessary ingredient of the firm

• People could hire others for wages and invest in businesses

• Firms grew larger and workers specialized in areas

• Machines made large-scale production possible

• The primary goal of the firm is to create a profit

• Its role is to create the goods and services that society needs

See page 142, “Adam Smith’s Wealth of Nations”

How Firms Think: The Importance and Calculation of Profit

• People within firms make the economic decisions about what, how much to produce and how to do it and help the firm make a profit

• Small firm, one person makes decisions

• Large firm, executive managers make decisions

• All decisions should take into account whether a firm is taking a loss or earning an accounting profit

• Accounting Profit is what we usually referred to as profit, the excess of revenues over cost

• Firms attempt to maximum profit

• Profits act as an incentive and a reward for the work that is done

• Profits are the producer’s least expensive source of money for expanding or improving production

• Profits are used to evaluate how well a firm is doing by being compared to profits of firms competitors

• Producers pay close attention to product lines to see which products are making the most profit

• Resources may be shifted to increase production of goods and services the meet urgent demands

• Profits allow privately owned companies to pay dividends to their shareholders

• Shares in companies are owned by pension funds, insurance companies, individual purchasing sticks or mutual funds through retirement saving plans

Theory of the Firm

• The Theory of the Firm assumes that producers are all profit maximizeers

• Adam Smith’s “invisible hand” creates the producers to increase their revenues and decrease their cost to increase their profits

• The theory of the firm can be expressed in a word equation:

Total profit = total revenues – total cost

Total Revenue

• Total revenue is the money a firm receives from its sales

• Two factors that influence how much revenues are made: the price decided to charge and the quantity sold at that price:

Total profit = (price X quantity sold) – total costs

• Firms must estimate the demand for a new product before launching it

Total Costs

• Higher prices don’t necessarily mean higher profit

• Higher price may reflect higher production cost or discourage sales

• Total Costs of production refers to the money the firm spends to purchase the productive resources it needs to produce its good or service

• Total Costs include suppliers, employees, landlords, bankers, etc.

• Cost are divided into two categories: Fixed Costs and Variable Costs

• Fixed Costs are costs that remain the same ate all levels of output. They must be paid no matter what the cause. For ex. rent, property, taxes, insurance premiums, and interest on loans.

• Variable costs are costs associated with labor, fuel, raw materials, and power. They change with the level of production. Total profit = (price X quantity sold) – (fixed + variable costs)

See page 145, Figure 7.3

The short run and the long run

• The short run is a period over which the firm’s maximum capacity becomes fixed because of a shortage of at least one resource

• The long run refers to a period when all costs become variable. In a firms long run there is no fixed costs of production

Marginal revenue and marginal cost

• If a firm wants to maximize its profit it should keep producing to the point at which the marginal cost of producing on more unit equals the marginal revenue received from the unit’s sale.

• When marginal coast exceeds marginal revenues the firm would waste resources and reduce profit

• A firm will maximize its profit by producing up to the point where its marginal revenue equals its marginal costs.

• Profits are maximized at a production level when

Marginal revenue = marginal cost

Efficiency: a firm’s ability to produce at the lowest possible cost, measured by either its cost per unit or its unit labour cost

Cost per unit: a measure of a firm’s efficiency, obtained by dividing total costs by the number of units produced

Unit labour cost: a measure of a firm’s efficiency, obtained by dividing its total labour costs by the number of units produced

Labour intensive (production): industry in which labour, rather than machinery, dominates the production process

Cottage system: production carried out in the homes of workers, characteristic of medieval times

Capital-intensive (production): production in which machinery rather than labour dominates the process, characteristic of the factory system

Economies of scale: the greater efficiency a firm can achieve when it produces very large amounts of output

Making Production Choices

Controlling the Cost of Production

**Producers have little control over their total revenue as consumer demand plays a major role in determining the market price of a good, and total sales (the two main factors that determine total revenues)

**Instead, firms try to focus their efforts on controlling their production costs—the firm that can produce the product at the lowest possible cost will more times than not, have a better chance at maximizing their profits—productivity and efficiency are important to firms

**Output per worker most common way to measure productivity—the skills, education, and experience of workforce are important; along with the quantity and quality of resources with which labour works—ex. A factory with machinery that is always breaking down will have less productivity than a factory with state of the art machinery

**How the work is organized is also important—when a firm improves productivity (and not its costs) it can produce more goods and services at the same costs—it can the offer its goods and services at a lower price making them more competitive

**If an economy can increase its productivity it means that more goods can be produced without increasing the amount of money being used, which means that the firms can sell their goods at lower prices in other countries (along with in their won country)—increased productivity increases competitiveness

**Cost per unit and unit labour cost are the most common ways to measure efficiency—cost per unit takes into account the total costs for making/providing one unit of the good/service, where as unit labour only takes into account the cost of labour it takes to create one unit of the good/service (usually given in relative number/measure rather than absolute)

**A firm/economy becomes more efficient when its productivity is increasing more than its production costs (view figure 7.6)

**If the efficiency of a firm decreases (or if the efficiency of its competitors increases), then the firm is at a competitive disadvantage—if a firm’s unit labour were to be increasing (with its competitors increasing at a slower rate, or decreasing) then the business will be less competitive and will lose both sales and profits

**Competitiveness is ultimately determined market by market and company by company

Choosing Production Methods

**In medieval times, most production was carried out in a labour-intensive fashion (in which most work was carried out by hand)—the people worked in small shops or in their own homes, and thus this approach was called the cottage system of production—most efficient way to produce—labour was cheap and plentiful, the market was usually small and locally based, and neither the technology or the funds were available to produce goods in any other way—most costs of production were variable costs that could be adjusted very easily in contrast with demand (very few fixed costs—were extremely low)

**Industrial revolution, which began in the 18^th century, brought new technology—business owners created large pools of capital, which they invested into a new type of business called the joint shock company (firms owned by many different members according to number of stocks/shares purchased)—transportation improved, trade became more certain, populations and markets grew—workers fled from their homes to large urban areas to work in factories with machinery

**Labour-intensive production gave way to the capital-intensive production of the factory system—made sense because the capital investments in buildings and machinery made the labour force more productive and the entire production process itself, more efficient—one major drawback was a sharp increase in fixed costs in contrast to variable costs, which made it difficult to increase production in a boom and decrease costs in a bad time—financial risks grew but so did the potential for a great profit, thanks to economies to scale

**Economies to scale refers to the ability of some firms to increase efficiency when they are producing a large number of units/goods/services/output. While some firms may become less efficient due to the laws of diminishing returns, other may see their cost per unit drop sharply as output increases—particularly true in firms that produce in a capital-intensive manner—has high fixed costs and low variable costs—increasing outputs basically allows a firm to spread its fixed costs over the increasing number of units being produced, which in turn rapidly decreases the cost per unit (see example discussed on page 149)

**Other benefits are derived from the greater specialization of labour that is possible in a large staff—large firms have more market power so they can better negotiate better prices from their suppliers

**Firms in private sector greatly determine the economic question of ‘how do we produce’ in a market economy—decision-making process involves the acquisition and balancing of economic resources (whose prices have been ultimately determined by resource markets)—ultimately, resources must be blended together and organized to avoid overall diminishing returns and maximize productivity at the lowest possible cost

The purpose of all economic activity is not only to make a profit but to also satisfy the needs of the consumer. 

Market: a group of buyers and sellers of a particular good or service.

Competition: the main thing that ensures firms remain responsible to consumers as well as to their managers and shareholders. 

Firms compete against one another indifferent ways.  They include as follows:

1)      Price: The lower the price the higher the demand for the product and therefore increased sales.

2)      Non-price Competition: firms that compete on the basis of quality.  Anything but price is changed.

3)      The competition for consumers involves the supply of a good product at a low price.  This involves producers using their resources to produce a new product more efficiently.  

Market Structure

Five factors help determine market structure

1)      The number and size of firms in the market

2)      How similar competitive products are

3)      A firms control over price

4)      How easy it is for firms to enter or leave the market

5)      The amount of non-price competition

Most markets and industries can be classified into one of four basic market structures.

These include perfect competition, monopolistic competition, oligopoly, and monopoly. On the market spectrum perfect competition and monopoly are opposite one another. See figures 7.10 and 7.11 for more information. 

Perfect competition

• Perfect competition is characterized by many producers and a uniform product. 

• The success of a firm in a competitive market depends on how well it manages its costs.  This means using the economy’s scarce resources efficiently so profits can be gained.

• Generating low prices can also be a disadvantage to a firm.  This will create more of a demand for a product and therefore more producers will become involved in the production of that product.  This will in turn generate lower profits for the starting firm. 

A perfect market can be distinguished by five main characteristics. See page 153

In reality, the perfectly competitive market does not exist, primarily because there are always some start-up costs and some use of non-price competition.  P. 154

Monopolistic competition

• When there are many different firms in a market and the product can be changed it is known as the market structure monopolistic competition.

• These markets are relatively easy to enter and exit.

• Firms are able to change their product to try to make it better then others so they can make higher profits. This is known as product differentiation, which creates some financial barriers.

•  Product differentiation leads to something called brand loyalty.  This is where consumers become more attached to a product and will therefore pay more for it to satisfy their preferences.  It is because of this brand loyalty that some firms have control over price.

Monopolistic competition can be distinguished by five main characteristics. See p. 154

Oligopoly

• Oligopoly is market structure consisting of a few large firms selling the same or slightly different products that each have some control over price.

• Oligopolies seem to have prices that are continuously rising and falling.  These prices seem to move the exact same way and time with every competitor, but tend to stay within a particular price range.

Oligopolies can be distinguished by five main characteristics. See p. 154

Monopoly

• In a monopoly one firm has complete control over the market.

• A firm may establish a monopoly by gaining legal control of its product and the right to benefit from its sales.  Governments can also give monopolies to firms by giving them full ownership of a product.

Monopolies can be distinguished y five main characteristics. See p. 156

Social cost: The transfer of part of a firm’s production costs (such as cleaning up pollution caused by the release of waste’s into the air, soil, or water supply) to the public (the third party); also called third-party costs. 

Third- party costs: Third party costs is the same as Social Costs

Production issues

Questions that are frequently asked when thinking about production

-What is the best way to produce goods and services to satisfy our needs?

-Should we depend on the Government for our needs?

-Should we rely on firms competing for profit in the market?

-Are there other options that we can take?

-What matters of public interest can we entrust to the marketplace?

Is Bigger Better?

            In terms of Adam Smith, he would have had particular concerns about the production methods of modern industry. Capital- intensive production can be more efficient but also results in fewer, very large producers competing as oligopolists (market is dominated by a small number of sellers). As the number of competitors in a marketplace drops, Smith’s “conspiracy… to raise prices” is more easily achieved. The benefits of efficient production and the economics of scale are more likely to go to the producer in the form of higher profits than to consumers in the form of lower prices.

            Normal market behavior may cause less competition, and without the pressure of competition to keep the prices down, they can easily float upward. Successful firms frequently use profits to expand production by purchasing their competitors.

Third-party Costs

Markets have so far flourished under capitalism, but this does not mean that it is perfect. Even a market with many small, privately owned firms will not necessarily ensure that economic resources will be used efficiently. Profit seeking producers try to reduce their costs of production to the least that they possibly can, while still producing a efficient product. Markets are not always good at passing on all the costs of production to those who consume the product. Pollution is an example. When the wastes from a production are released into the water, air or soil rather than being properly treated as part of the production process, the firm effectively passes on the environmental costs of production to others. These non-monetary costs are called social costs or third party costs. Achieving production efficiency by reducing the costs of production can lead to the destruction of scarce resources rather than their efficient use.

The Public- Private Balance

            The government has been found wanting as an efficient provider of goods and services. After the year 1960, government expanded its role as producer, particularly as a provider of essential services, such as health care and education. This increased role resulted partly from a growing population. It also came from the belief that the government was able to satisfy essential needs better than markets and the private sector. By the year 1990, however, government spending got way out of control. Annual deficits grew at alarming rates, and our accumulated public debt was threatening the well being of both the present and future generations.

            During the 1990’s, the government cut its spending, its payroll, and it’s services. It downsized and deregulated markets. Canada cut its levels of social spending faster than any other developed nation.

Is regulation the answer?

            Markets cannot exist without regulations that define contracts, protective private property and competition, or require certain production standards. Regulations must effectively enforced. If markets don’t work, it may be because they are poorly regulated. Competition Act and other statues control competition. Its main role is to promote and maintain fair competition so that Canadians can benefit from lower prices, product choices and quality choices.

            In Canada, regulation is a matter of public policy and decided by public debate. The debate should be based on the values we think are most important. We should ask ourselves, if the ways in which we produce goods and services can be regulated to serve the ultimate needs of society.

            Even with the perfect set of regulations, however we should not expect the market to do more than it can. We want an economy that responds to our needs, but markets can only respond to demands.

            Organizing our scarce resources to provide goods and services that are efficiently produced and equitably consumed is a matter of public debate and regulations to which we can all contribute. It is our economic responsibility, as citizens, to address this issue, because we will enjoy the benefits or bear the costs that result.

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Chapter 8

Labour as a Resource Market

Recall that the basic factors of production are land, labour, entrepreneurship, and capital goods.  Firms decide how much of each factor to use based on the relative price that the producers face for each of these inputs and how much additional revenue each is likely to provide.  They decide this by looking at the markets for resource inputs.

•                     The labour market is a complex system of interrelated factors based on supply and demand, just like the market for many other goods and services.  The difference in this market, however, is that households are the suppliers, business firms are the comsumers, and the price is the wage rate. (Page 171)

Demand for Labour

•                     The understanding of labour demand is easier is we compare it to the demand for goods and services.  Both refer to a quantity demanded for a certain price.  Direct demand refers to the demand for goods and services, consumers determine it directly when they decide how much they are willing to pay for a certain amount of goods.  Derived demand is the demand for labour and resources, because while it depends on the consumer demand for a product or service, it is related to it. 

•                     The more quantity demanded for a good or service, the higher the demand of labour.  However, the demand for labour depends on more than just product demand.  It also depends on productivity, how much each worker can produce in a certain period of time, the price for the good or service, and the wage rate.        

•                     The marginal revenue product of labour (MRPL) is the amount of additional, or marginal, revenue that is generated for a firm as a result of adding one or more worker(s) to the production process.  In a perfect competition market, the MRPL is the price of the good multiplied by the marginal product.  There is an example of one firms use of MRPL on page 17, second column, last paragraph .

•                     Here are the major points brought forth by the example.  Decreasing MRPL is caused by the law of diminishing marginal returns.  Each new worker makes less marginal product,  therefore less marginal revenue product.  When a firm is deciding how many workers to hire, they will consider the wage rate compared to the MRPL.  They will hire additional workers until the wage rate equals the marginal revenue.  If the price of labour increases, wages, firms would have demand for less workers. 

Market Demand Labour Curve

•                     The market demand labour curve is the graphical representation of the quantity of labour demanded by all firms in an industry at each of the positive wage rates. (Figure 8.2, page 172)

•                     There are three factors that could cause a shift in the market demand labour curve.

•                                 A change in the demand for the product of labour~Because the demand for a product influences the labour demanded, a shift up in product demand, means more product needs to be produced, therefore more workers are needed.  This would cause an upward shift in the demand curve.  The opposite would happen if demand for a product went down.

•                                 A change in the price of other productive resources~If the price of another productive resource, such as capital goods, were to increase, so would the demand for labour.  The opposite is true for a decrease in productive resources.

•                                 A change in worker productivity~If workers increase there productivity, the demand for labour will increase.  This increase in productivity could be caused by more training, improved worker management, and more or improved capital equipment.  A decrease in worker productivity will cause a decrease in the demand.

Supply of Labour

•                     The market labour supply curve shows the number of works who are willing to work.

•                     Opportunity cost in relation to worker, refers to what other things the person could have done with there time, or other ways they could have earned money.

•                     At higher wage rates, more people are willing to work, giving the market supply curve an upward slope.

•                     Other factors that influence the labour supply curve include specific skills needed for certain jobs, specific characteristics of the job, and geographic location.

•                     There are four factors that influence the labour supply curve.

•                                 Changes in income tax~ This means that government is taking more or less money from the workers wages.  If income tax increases, the supply will decrease, and if it decreases, the supply will increase.

•                                 Changes in size and composition of the population~  If more people move in to an area, labour supply will increase, and vise versa if people move out.  Also, the age distribution of the population will change the labour supply in that as people get older they will retire, decreasing the labour supply.

•                                 Changes in household technology~  When opportunity cost is decreased, workers do not need to spend as much time at home because technology has increased.  This causes an increase in labour supply.

                        Changes in attitude about work~ As women’s rights continue to expand, more and more woman are entering the labour force.  Also, as more people become aware of racism, stereotypes, etc. More workers enter the labour force.  This causes an increase in the labour supply.  Also, as age restrictions are put in place, the labour supply decreased.

Wage Determination

• Equilibrium in the labour market is achieved when wages are agreed on between amount of labour supplied by households and quantity of labour demanded by firms  

• If wage is too low a shortage occurs because the quantity demanded is higher than quantity supplied

• If wage is too high a surplus occurs because the quantity of labour supplied is higher than the quantity demanded

• The wage that is stable is when there is no shortage or surplus, therefore the market is at equilibrium

• Wage differentials are differences in wage rates among different labour markets

• Wage differentials are a function of labour supply and demand

• Non-monetary benefits in certain jobs influence supply and demand

• Length of vacations, hours of work, working conditions, and fringe benefits all must be factored into individual labour markets

• Jobs are often described as being “high-skilled” or “low-skilled” in order to simplify analysis of the labour market

• Theses categories (high-skilled & low-skilled) is a significant factor in determining wage rates by the level of training that a worker has received

Concept of Human Capital

• Human capital refers to the knowledge, skills, and talents that workers have, whether it is accomplished through education or by nature

• Education is an investment in human capital

• Individuals invest in their education to be more marketable in the future

• People want to specify in an area of the labour market where the demand for labour is high, and the supply of labour is low to obtain higher wage rates

• Firms invest in human capital through on-the-job training, and supporting further formal education for their employees to raise productivity and improve the marginal physical product of labour

• Governments invest in human capital by subsidizing (supporting financial in) public education, some post-secondary education, and numerous job-training programs to improve efficiency, which expands productive capacity of the economy and promotes economic growth

See figures 8.8-page176, 8.9-page 177

Strikes and other Job Action

• Most disagreements are settled without a strike or lockout, but they are sometimes needed in order for the employee and employer to reach an agreement.

• One of the most well known tools used by unions are strikes, which occur when employees refuse to go back to work in order to meet their demands and can occur only if the majority of workers agree to it.

•  Another method used is lockout, which occurs when an employer shuts down employment in order to get workers to agree to new standards.

• Work-to-rule is another method used by unions where workers only do the work stated in their contract. 

• A boy-cott may also be used where employees will ask the public not to purchase the product being produced until demands are met.

Other Activities

• One of the main goals of unions is to try to raise wages being paid to employees.  This is done by increasing the demand for labour or the product, which in turn will increase wages.

• May also try to decrease supply.  For more info. See page 189

Impact of Unions

• Unions protect workers from being laid off based on the number of years they have worked there.

• Unions have been blamed for inflation in prices because as wages go up, prices also go up as well.

• They have also been blamed for being one of the reasons for high unemployment rates because of their pushing for higher wages.  Some say that this pushing is a result of better working conditions.

• Unions have contributed to the governmental laws surrounding the workforce.

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UNIT 3

Chapter 9

The study of economics as a whole is known as Macroeconomics. In modern terms macroeconomics is like the pixels on a computer monitor. Individually, one can look at a pixel and say that it is red, blue or some other color. In order to understand the complete picture, one must look at the many thousands in the picture as a whole. All of these pixels together create a picture. This is very much like macroeconomics. All the markets, consumers, workers, and firms together create the “big picture” of our economy.

Why measure performance?

There are several reasons why we measure the economic performance of our country. The reason we measure the performance is:

• Measuring the national economy’s performance helps governments decide on tax policies and spending priorities

• Governments use this information to measure the effect of their economic policies

• Performance measures allow us to compare our economy to the economies of other countries.

• Performance measures allow us to look at the role and impact of specific industries on the whole economy

• Unions and wage earners use economic measures in contract negotiations

• Individuals and businesses use economic measures to help them make investment decisions    

There are many different macroeconomic measures. There are only three that receive the most attention in our economy: outputs, employment levels, and price stability.

Gross domestic product- The gross domestic product is the most common method used to determine the amount of outputs from a particular country. GDP is the total market value of all final goods and services produced within a country.

The GDP of a particular country can be calculated in two ways. The first way is to add up the total that is spent on all final goods and services in one year--- the expenditure approach. The other way is to add up all the income that is earned by different factors of productions in producing the final goods and services--- the income approach. The GDP in each case should be the same.

Multiple counting- is inflating the size of the GDP by including the value of the components of the final goods in total.

The expenditure approach

 To calculate the GDP using the expenditure approach you must use the following formula:

GDP= C + G +I (X –M)

C- consumption (what households spend on goods and services)

G- government purchases

I- Investments (this refers to the purchase of new capital goods)  

(X –M)- the value of the exports minus the value of imports

Until the year 1986, Canada used a slightly different method for measuring outputs. This method was known as Gross National Product. The GNP was the total value of all final goods and services produced by Canadian- owned factors in Canada and anywhere in the entire world.

*Note- because GDP is calculated based on the market prices at the time that the good are sold, changes in the level of prices from year to year that comparing different years can produce misleading results.

GDP is often used as a tool for measuring the economic growth of a country- how much a country’s economy has expanded from one year to the next.

The formula for calculating the growth of a country is as follows:

                            (Real GDP year 2-

Real GDP      =     real GDP year 1)    X  100

Growth rate           real GDP year 1

(Read example on page199- bottom of the page –left side)

There are several drawbacks with the use of GDP. Some of these are:

• Population size- Comparing the GDP for different years may be very misleading if the population of the country had changed significantly.

• Non- market production is not measure- GDP does not count any output that has no dollar value attached to it.

• Underground economy- this is another type that is not measured in terms of GDP. These are transactions for which no paper trail exists.

• Types of goods produced- the is the inclusion of all goods and services that are produced weakens the GDP as a measure of well-being.

• Leisure- the GDP could grow significantly if all workers began to work 24 hours a day and seven days a week

• Environmental degradation- Services such as pollution do not make our country better off but the production of these goods and services that create problems are added to the GDP.

• Distribution of income- GDP does not take into account how evenly the income in a country is distributed among citizens.

•  

United states senator Robert Kennedy once summed up the drawbacks of the measures of GDP as:

GDP (GNP)…counts the air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for those who break them. It counts the destruction of our redwoods. Yet the gross national product does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages…it measures everything, in short, except that which makes life worthwhile.

*Note- Remember that all statistics have their limitations.

Unemployment rate- the amount, in terms of percent, of how many people in a particular country who are not employed.               

 Measuring Employment Rate: The Unemployment Rate

• The unemployment rate is the percentage of the labour force not working at any given time

• Canadians are put into three categories, under 15 therefore unable to work, people who can but are not willing (unemployed), and people who are working or are seeking work (labour force).

• Unemployment rate = number unemployed/labour force X 100.

• There are three major criticisms of Statistics Canada for the definition of the labour force; everyone who earns money is employed, even those who want full time positions but only have part-time; It does not include people who have been looking for work for a long time and given up, only those actively seeking jobs; and there are many people accepting jobs for which they are overqualified.

• Full employment does not mean every one able to work is working, it means that only 6-7 percent of eligible people are unemployed, also known as the natural rate of unemployment.  This is because at any time there are people going from job to job, for example.
  

• Measuring Price Stability: The Consumer Price Index

   

  • Inflation is the rise or fall in the general level of prices.

  • The Consumer Price Index or CPI is used to track inflation.  It is a price index that measures the changes in the price of consumer goods.  Stats Canada uses 600 goods and service, determining the spending habits of a household (and urban household of exactly 4 people).  Each good or service is put into one of eight categories and weighted to reflect how important they are in a typical household.

  • Inflation Rate is the annual percentage by which the CPI has risen.  Inflation rate equals (CPI year 2 – CPI year 1)/CPI year 1 X 100.

  • Indexing is measuring how much wages and pension payments should be adjusted to offset year-to-year indexing.  These adjustments can be made to remove all the effect of a price increase.

  • The CPI has limitations.  The first issue is the weighting of the categories and the items included (figure 9.9 page 207).  Another problem is the objects in the base year basket.  Because of technological advances, consumer preferences, etc. these base items may become irrelevant.  A third concern is cultural diversity.  Consumers will buy different products depending on their background, like clothing, household items, and food.  It should also be noted that a household by the CPI standards was an urban family consisting of no more no less than 4 members.
    
    Real GDP

  • The real GDP is the total value of all goods and services produced in Canada in any given year, adjusted for price changes.  Up until May 2001, GDP was measured by nominal GDP divided by the GDP deflator multiplied by one hundred.  Nominal GDP is the total value of the output of an economy before the effect of price increases is removed.  The GDP deflator is based on a representative basket of all the goods and services in the GDP.  The GDP deflator was used to remove the effect of inflation and create the real GDP.

  • To compare the GDP between two years to see whether real growth occurred, the nominal GDP for each year must be converted to real GDP. (Page 211)  An example of this can be found on page 211.

  • The chain Fisher volume index replaced the GDP deflator after May of 2001.  It eliminates the use of a base year, instead using a formula to “rebase” the GDP every quarter (or three months).
    
    

   

   

  
  

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Chapter 10

Introduction to Fiscal Policy

   Unemployment rate, inflation rate, economic growth, production possibilities curve, equilibrium, labour, capital markets, and efficiency are concepts that form the foundation to understand how the macroeconomy works

Aggregate Demand and Supply

   Like how the total demand schedule for an economy is determined we can do the same with supply by adding up all of what producers are willing to supply, at all various price levels, for all markets

   The combining of all markets for individual goods and services in society, it is the aggregate or total for the entire economy

Aggregate Demand

   Aggregate demand (AD) is the total demand for all goods and services produced in a society

   Aggregate demand schedule displays the total amount of goods and services purchased at each price level

   The aggregate demand curve looks very similar to the market demand curve

   As price levels rise, the aggregate quantity demanded falls

   Aggregate demand at each price level is alike to the GDP that would occur at that price level, or the sum of all consumption, investment, government spending, and net exports (imports/exports) in the economy

GDP = C + I + G + (X – M)

   For economic growth, the aggregate quantity demanded must increase at each price level, which means that one or more of the variables in the GDP formula must increase

Aggregate Supply

   Aggregate supply (AS) is the total supply of all goods and services produced in a society

   Aggregate supply curve displays the total amount of goods and services that would be supplied at each price level

   At very low outputs, most of a society’s resources are sitting idle. As output increases, price levels would stay low

   More output produced means more competition among producers for limited amounts of land, labour and capital inputs. As these resources become scarcer, prices go up and an upward pressure is put on the prices of all goods and services

   At higher output levels, prices rise rapidly

    Producers want higher input without producing more output. The Aggregate supply becomes perfectly inelastic, or vertical, at that level. This point/level of output is at the production possibilities curve

Equilibrium Output and Price Level

   Where the AD and AS curves intersect is the equilibrium point of price and output

   Full-employment equilibrium, the two curves intersect where the AS curve rapidly rises

   When the economy approaches full employment, the competition for scarce resources starts to push price levels up. The economy can still increase real GDP by increasing output beyond the full employment level by having workers work overtime

   The AS curve becomes vertical when absolute capacity is reached

   Full-employment equilibrium is the point that price levels start to rise more quickly below the absolute capacity

   When below full employment equilibrium where the AD curve intersects the AS curve real GDP is lower and price levels are rising slowly

   The low level of output leads to higher unemployment levels which is a recessionary gap

   Recessionary gap is characterized by high unemployment, low inflation, and low GDP growth

   When the AD curve intersects the AS above full employment equilibrium real GDP is very high with high employment levels and high price levels which is a inflationary gap

   High inflation, high employment levels, and high levels of GDP growth characterize inflationary periods

Check back for notes on pages 220-225

The Business Cycle

Leakages and Injections

The business cycle centers on the money payments that flow through an economy.  Businesses hire people to work for them and pay them wages.  The people then spend their money on the goods and services that the business produces.  This continues on in a circle flow.

Leakages are known as any use of income that causes money to be taken out of this circular flow.  There are three well-known leakages, which are money paid into taxes, savings that people keep from their income, and money spent on imported goods.

Sometimes leaked money ends up getting spent back into the economy.  This is known as an injection, which is defined as any expenditure that causes money to be put into the circular flow of money. The three major injections are government spending, investment spending, and exports.

The relationship between the leakages and injections determine whether the overall demand is growing or shrinking.  If the sum of the leakages is larger then the sum of the injections then the demand is shrinking.  However, when the total leakages are less then the sum of the injections then the demand is growing. 

See P. 227 lower left had column for bathtub example. 

Fiscal Policy

Keynes’ Ideas

Keynes said that if government policy could affect the size of leakages and injections then aggregate demand could be managed. He said that aggregate demand could be purposely increased and purposely decreased. 

The Basics of Fiscal Policy

Fiscal Policy is when a government uses its powers of expenditure, taxation and borrowing to change the size of the circular flow of income in the economy to reach some economic goals.  When the spending by households is too small government can increase its own spending or encourage private spending and therefore increase aggregate demand. If private spending is too large the government can decrease its own spending and discourage private spending. 

Expansionary Policy

Aggregate demand is way too low when an economy is in recession.  Unemployment is high and there is little growth in output.  It is then that the government may wish to increase aggregate demand by using an expansionary fiscal policy.  To do this government would have to cut taxes, increase government spending or do both to stimulate economic growth and lower unemployment rates. 

Contractionary Policy

When an economy is suffering from inflation, aggregate demand is too high. Employment is high and there is high economic growth in output.  The government may then wish to decrease aggregate demand using a contractionary policy.  To do this they would have to increase taxes and decrease government spending or both to reduce upward pressure on prices. 

Tools of Fiscal Policy

Changes in Spending

If the government wants to motivate the economy, it can increase its general spending in its budgetary programs such as health care and it can also undertake infrastructure programs.  These programs might include building roads and so on. 

Changes in taxation  

To stimulate economic activity the government can also change the amount of tax that it collects.  To do this it could 1) raise or lower personal and corporate income taxes and or sales and excise taxes.  2) Alter tax exemptions or tax credits. 3) Provide special tax incentives for investment. 

Automatic stabilizers

Automatic stabilizers start acting on aggregate demand before a recession or inflationary trend takes hold.  These stabilizers are built into an economy and automatically increase and decrease aggregate demand.  For example a progressive tax acts as a stabilizer in that it rises as income rises and has the effect of increasing a leakage as incomes grow.   Any built in mechanism that increases or decreases government spending and taxation as the business cycle fluctuates is considered to be an automatic stabilizer.

Government Budget Options

The Governments in Canada usually announce their changes in revenue and spending plans in the spring by outlining the coming year’s budget. Once the budget has been established the government can end up in either one of the next three situations”

·        A deficit budget occurs when the governments spends more than it collects in tax revenue.

·        A surplus budget occurs when the government collects more in tax revenue than it spends. When this happens there is money left over.

·        A balanced budget results when the government spend an equal amount to that of which it has collected through tax revenue.

The term dept is often related to deficit. The word debt means that, for example, the government has spent more money than it has collected in taxes so then it is in debt, which means that it owes money that it has borrowed to fund deficit budgets.

Annually balanced budgets

Until the 1930’s, the primary goal of fiscal (government finances) policy in Canada was to ensure that government expenditure each year did not exceed revenue- in other words, the amount that was taken in should equal that of which is being spent.

Cyclically balanced budget

According to Keynesian economics, governments should use their fiscal policy to achieve a high, stable level of national income with niether unemployment nor inflation. If an economic recession begins, the government should start to spend more than it receive in tax revenue. During a recessionary phase, governments should run deficits by increasing government spending, decrease taxes, or both. During an inflationary phase, governments should run surpluses by decreasing government spending, increasing taxes, or both. The government’s role is to act as a stabilizer in times when the economy is weak or unstable.

Deficit and surplus budgets as necessary

An extension of Keynesian theory held that fiscal budgets could be managed from the perspective of running deficits or surpluses when necessary.  A deficit budget would be used only when the economy needed a boost. If a debt was accumulated as a result, so be it. The health of the economy was more important that the balancing of budgets over the business cycle. Since the great depression, the expansionary periods have been longer than the contractionary periods, so a large debt should not be an issue. By the year 2000 Canada $564.8 billion.

Economists have identified two components to budgets deficits. The cyclical deficit is that part of the deficit that is incurred in trying to pull the economy out of a recession. The second component, the structural deficit, is the amount above the cyclical deficit that would exist even if the economy were operating at full employment.

Full-employment budget

The latest thinking on fiscal policy is that governments should try to achieve a non-inflation, full-employment level of output. That is, they should only intervene with fiscal policy when the economy falls below its full-employment targets.

Drawbacks and limitations of fiscal policy

There are a number of limitations and drawbacks to using the fiscal policy. They are:

• First there is the recognition lag, or the time that the government takes to recognize a problem in the economy. Second, there is the decision lag, the time required for the government to determine the most appropriate policy. Third, there is an implementation lag: once the decisions have been made, various government departments have to figure out just how to implement the new directives regarding spending and taxation. Finally there is the impact lag. Once the policy is in place, time is required before its full affects can be felt through the multiplier affect.

• The government might have difficulty changing spending and taxation policies.

• Conflict between the various levels of government regarding the appropriate fiscal policy might limit effectiveness.

• Regional variations may exist that interfere with the implementation of fiscal policy.

• The size of the debt can also limit the use of the fiscal policy as an effective tool. For example in the recent years the federal debt in Canada has grown so large that there is much political pressure not to increase it further.

• Some economists believe that a crowding out of private investments occurs when the government competes with the private sector to borrow funds to finance the debt.

• Deficits redistribute income form all taxpayers to bondholders.

• Deficits impose a net on future generations because the foreign-owned portion of the debt removes capital from the country when interest is paid.

(Note* For more information on these draw backs and limits look at page 238-240)   

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  Chapter 11

The History of Money

• Money is used to pay for all the goods and services that we purchase from individuals or businesses.
• Money was not suddenly invented, it slowly revolutionized over thousands of years.
• Before money objects were traded using a barter system.  The value of a good was determined compared to another good, a cow for two goats for example.
• This formed a problem of double coincidence of wants.  This means that if you wanted two goats in trade for your cow, you had to find someone who wanted a cow in trade of two goats.  What are the chances?
• Cattle were the first type of money; they became the measure of value for all goods.  They eventually became “money” in that they were used to buy other goods and services.
• However, as the world began to evolve, less people needed to live off the land, because many places were producing a surplus of food.  So, the people who decided not to be farmers become other things, such as doctors, priests, government officials, etc.  These people needed a way to obtain food and other necessities to live.  This is how money became vital for people to have, especially as economies became more developed.

The Evolution of Currency

·        Commodity money is things that have value in itself, such as cattle.  However, cattle couldn’t be used in small transaction because you couldn’t give someone a piece of cattle without killing it first.  So, eventually metal began to replace cattle by such things as metal picks, hoes, and fishhooks.

·        About 5000 years ago, gold, silver, and copper were used as commodity money.  They were given a value by how much they weighed.

·        The next stage was to mint the metals into different coins.  Gold and silver began to overtake the use of commodities.  This was the first form of money as we know it today.

·        Imprinting the head of a king or queen on coins came about after Alexander the Great amassed his empire.  It was done to guarantee the purity and weight of the coin.

·        There were two ways to cheat with theses new coins.  The first was called clipping, a process by which small savings of from the edges of coins were collected.  Another process was sweating, done by shaking the coins in a bag, then collecting the dust created.

·        Paper was the next stage in the creation of money.  The Chinese were the first to develop paper money.  Paper began as receipts, a way to transfer ownership of coinage from one person to another. 

·        People who had large amounts of coins thought it was safest to give their coins to a local goldsmith and take a receipt for it.  Then, they could just give the receipt to whoever they owed money to as payment. 

The Origins of banking and money creation

·        Goldsmiths realized that people seldom wanted to retrieve all their gold at once, because the receipts were user to use.  So, the goldsmith could take a loan from the coinage or metals and charge the borrower interest, creating a profit for himself.  The borrower would have to pledge property if he did not pay the loan back.  The only recognition of the loan was written in the goldsmiths account book.

·        This was how banks were created.  The goldsmith’s lent and borrowed money, charging interest, thereby making a product.  This also created money, the paper currency used a receipts, and by the notations in their account books.

·        This original system of banking is known as fractional reserve banking.

·        If borrows and owners of the coinage had wanted their money all at the same time, the goldsmiths, or “bankers”, would have been in trouble, and this has occurred at a time or two in every country.

·        If a financial crisis occurred, like poor harvesting or war, people would ant to retrieve all of their money, which the bankers wouldn’t be able to give, so they would have to declare bankruptcy.  The collapse of many banks in the 19th and 20th centuries, combined with problems caused by paper and coinage, led to demands for central banks.

·        Central banks were used to regulate the private banks in a country, provide security for their costumers, and issue currency. 

·        The gold standard is a promise by government that it will exchange gold for the national currency on demand.  Central banks assumed (like goldsmiths) that not all the national currency would have to be paid at the same time. 

·        Fiat money is money that represents value because governments have declared it a legal tender, not because it is valuable itself.  Legal tender is money that government has declared must be accepted within the national economy as payments for goods and services.  The government did this because they feared everyone would want their gold at the same time.  So, in actual fact, it is fiat money that we use in today’s economy.

·        Currency (coins and paper) only compile 7 to 8 per cent of the total money supply in more developed countries.  Bank deposit money,  money composed of people’s deposits and loans granted by the banks, make up the bulk of all money supply.

What is Money

Money is anything that is generally accepted as payment for goods and service

Money has evolved a lot over the years going from gold and silver to coins and paper

We are now moving into another stage- Electronic Money

Electronic Money: money in electronic networks, or cash cards that can be used by consumers

The Functions of Money

Money will be accepted as long as it performs the three functions, which it is designed: 1. a medium of exchange, 2. a measure of value, 3. a store of value

A Medium of Exchange

Barter requires a double coincidence of wants, people must want what the other has to offer and vise versa

Money as a medium exchange saves time

Cash is legal tender in Canada so it can be accepted for all payments whereas cheques and debit cards are not legal tender so they are not accepted for all payments

A Measure of Value

As a measure of value or standard unit of account, money allows us to compare value of various goods in our economy

Measure of Value: a function of money that allows comparisons of the value of various goods and services; also called standard unit of account

With a money system there is a unit of currency that serves as a standard which allows us to measure the value of a good or service and compare its value with other goods and services

A Store of Value

Money serves as a store of value, or an instrument for storing purchasing power for the feature

Store of Value: a function of money that allows value to be stored for the future, allowing it to be used in the purchase of goods and services

Liquidity: the relative ease with which an asset can be used to make a payment. Money is the most liquid asset.

Other assets are less liquid because they are not so easily exchanged for goods since they must first be sold in order to obtain money

The Characteristics of Money

Characteristics that enhance money’s acceptability

Money is portable and easy to use

Must be durable because of being passed from being passed around

Must be easily divided into units to make it easier to purchase both small and large

Should be recognizable by shape and colour due to mistakes during monetary transactions

Made of materials and designed so that it is difficult to duplicate

Must keep value over time

Measuring Canada’s Money Supply

Money Supply: the total amount of cash in circulation outside the banks plus bank deposits

People hold different types of bank deposits

Near Money: deposits or assets that can act as a store of value and can be converted into a medium of exchange but are not themselves a medium of exchange

Components of the Money Supply

• Demand deposits: bank deposits (such as chequing accounts) that can be used to make immediate payment

• Chequing accounts: an account that serves primarily as a medium of exchange, paying little or no interest

• Current accounts: a bank account for a business that operates like a chequing account, paying little or no interest and serving as a medium of exchange; also, part of a balance of payments account that records totals for three components: goods, services, and investment income

• Savings accounts: a bank account that allows holders earn interest on saved money

• Term deposits: bank accounts in which the holder agrees to deposit a fixed amount of money for a fixed period of time for a fixed interest rate

• Notice accounts: a deposit that requires the depositor to give some notice to the bank before withdrawal of fundsMoney market mutual funds: mutual funds specializing in short-term governmental and corporate securities

Definitions of the Money Supply

• The bank of Canada has broken down the money supply into several categories ranging from a narrow definition to a very broad one

• M1: the narrowest measurement of the money supply, comprising cash in circulation along with chequing and current accounts

•  M2: a larger measurement of the money supply than M1, comprising M1 plus all types of personal savings accounts, term deposits, and non-personal notice deposits

• M2++: a larger measurement of the money supply than M2, comprising M2, plus deposits at non-bank deposit-taking institutions, money market mutual funds and annuities 

• M3: a larger measurement to the money supply than M2++, comprising M2++, plus foreign currencies held by Canadians and large term deposits held by businesses

• The bank of Canada adjusts policies (such as the level of interest rates) to support our economy’s growth based on an accurate measurement of the money supply that is actually being used for transactions in the economy

• M1 is legal tender, and includes chequing accounts along with debit cards

Three main categories of financial institutions:

1. Deposit Taking and Lending Institutions: these include charter banks as well as near banks, which comprise trust companies, mortgage companies, and credit unions. Chartered banks have a close relationship with the government…near banks are closely related to chartered banks as they operate somewhat similarly, but they are not allowed to use the word bank in their names. Trust companies accept deposits as well as administer estates and trusts, mortgage companies invest their depositor’s assets into real estate, and credit unions are cooperatives that offer banking services to their members.

2. Insurance companies and pension funds: they cover individuals and businesses against fire, damage, automobile accidents, and other risks. Pensions are pools of capital invested in financial assets such as shares, bonds, and real estate, in order to provide retirement income for its investors. 

3. Investment Dealers and Sales and Finance Companies: Investment dealers sell new issues if company shares to the public and act as brokers for the investors in the stock market. Sales finance, and consumer loan companies lend money to businesses and individuals.

 **Six of the largest banks in Canada dominate our financial system, owning 70% of its total assets. Their lending services make it possible to create the goods and services of our economy.

The Canadian Banking System

**Two main types of banks which a modern economy operates on—unit banking system (allows many independent banks to exist but sometimes puts restrictions on how many branch banks are allowed to be established) and branch banking system (restricts the number of banks that can be established but does not restrict the number of branches each can establish). USA is an example of the unit banking system with over 14,000 different banks where as Canada is an example of a branch banking system with only a few banks and many branches.

 **One of the main advantages of a branch banking system in the past had to do with security. If someone came to a branch bank with a big unexpected withdrawal which this establishment itself could not handle, then it would go to the other branches of that bank and together they would be able to cover the withdrawal. In the USA this would not be possible—a bank cannot draw on another bank.

 **Canadian banking system criticized for having only a few large banks in comparison to the many banks established in the USA. In 1998, 4 of Canada’s largest banks tried to come together to make 2 banks, claiming they needed to be larger in order to compete internationally. This did not happen.

The Chartered Banks

**At present time Canada has 13 charter banks—six of these banks with over 90% of Canadian banking assets and about 8,000 branches across the country dominate the Canadian banking system (see figure 11.2)

 **The top 6 banks have many international branches in the USA, Latin America, the Caribbean, and Asia which contribute to a lot of the banks revue. In 2001, they (the banks) earned 50% of their revenue outside of the country.

 **In the 1980s, these 6 banks were rated among the top 25 in the world, in terms of assets.

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  Chapter 12

What the Bank of Canada Tries to Do

In chapter ten we learned that during an expansionary phase of the business cycle, people get higher incomes, and businesses take in larger amounts of profit. This causes people to start borrowing money for cars, houses, and other big ticket items. So, the bank was play the bad guy, and raise interest rates to slow down borrowing. They do this to prevent consumers from fueling demand for goods and services so much that the inflation rate will increase drastically. But the bank must be careful, bad timing or to much restraint could put the economy into a recession.

During a recession, the bank will lower increase rates to encourage borrowing, therefore increasing consumer and business spending.

Easy Money is the term used to describe monetary policies of low interest rates, easy availability of credit, and growth of the money supply. These policies are used to slow down and reverse recessions.

Tight money is the term used to describe monetary policies of high interest rates, difficult availability of credit, and a decrease in money supply. This is used to restrain an economy during an expansion.

The Role of Interest Rates

Interest is price paid for a loan. Interest rates have a large deciding factor in a consumers choice in saving and borrowing money. A supply and demand graph relating ot interest rates is given on page 270.

The demand for loanable funds comes from consumers, businesses, and government. As interest decease, more loanable funds are borrowed, and vise versa. Three examples of the way interest rates affect purchases are given on page 270.

The rate of return is the amount of extra revenue an investment by a business in new machinery, new technology, or a new plant will bring in.

The supply of loanable funds comes from individuals, businesses, and chartered banks. Three examples of how interest rate affects loanable goods are given on page 270.

Changes in Interest Rates

The supply and demand for loanable goods can affect interest rate. Demand for loans can increase when people have more money coming in, or when baseness fell that they are safe in expanding. This will cause interest rates to increase. During a recession, when people are not as willing to borrow, interest rates will decrease to compensate.

The supply of a loanable good can increase when the economy is doing good and people decide to spend more, and save more because of higher incomes. Also, high profits for businesses encourage them to save a greater percentage of their profits. These changes increase the amount of funds available to chartered banks for lending. As supply increases, the interest rates fall. During recession, people aren’t saving as much, and sometimes withdrawing there funds. Therefore the interest rates increase because charter banks have less loanable funds.

Different Types of Interest Rates

One type of interest rate is that on credit cards, where the more money you owe, the longer the pay off period, therefore the higher the interest (or something of that sort). Another type of interest rate is the prime rate, which is the lowest interest rate institutions will offer to its best costumers. It serves as a benchmark for other interest rates the institution offers to its other costumers. When offered a loan, the costumer will be offered a rate that is above prime, a number that varies depending on the persons credit, the amount of the loan, the term of the loan, and the amount of other dealings the individual does with the institution. A third type of interest rate is bank rate. This is the rate of interest charged by the Bank of Canada for loans made to chartered banks and other financial institutions. If this rate rises, other banks usually rise their interest rate, or vise versa.

Inflation Premium is an allowance for inflations that is built into all interest rates. Because over time, prices rise and fall, the amount paid back to a lender could be more or less than the original amount (example on page 273, third paragraph). This is why inflation premium is used, to compensate for the general rise or fall in price.

The interest rate that includes an inflation premium plus an allowance for risk is called the nominal interest rate. Once the expected rate of interest is subtracted form it, we get the real rate of interest.

Real rate of interest = Nomianl rate of interest - Expected rate of inflation

The banks primary goal is to keep price stability-low inflation rate

The banks plan is to keep the inflation between a 1 to 3 percent band

Falls close to 1 than the Bank decreases short-tem interest rates-easy money policy

Rises close to 3 than the Bank raises rates to pull inflation down-tight money policy

Bank of Canada controls inflation rates by its ability to change its Overnight Rate Target

Overnight Rate Target: a monetary tool used y the Bank of Canada to control the Overnight rate; it is set by the Bank of Canada at the midpoint of the operating band

The rate that the bank pays interest on its deposits is half a percentage lower than the Bank rate

The 0.5 percent range between the two rates is called the Operating Band

Operating Band: the range of 0.5 per cent between the bank rate charged by the Bank of Canada and the interest it pays on deposits; the overnight rate target is set at its midpoint. For example, if the central bank sets the overnight rate target at 3.75 per cent, it will charge a Bank rate of 4.0 per cent for loans and pay 3.5 per cent for interest on deposits. The operating band would be between 3.5 and 4.

Chartered banks pay one another a rate within the operating band when borrowing money from each other

The actual rate charged becomes the Overnight Rate

Overnight Rate: the rate of interest, controlled by the Bank of Canada, that is charged by financial institutions on short-term loans made between them; it is set within the operating band

By changing the overnight rate target the bank tells other banks and institutions the direction of monetary policy

An increase in the target encourages other banks to increase their own interest rates

See figure 12.5 and 12.6 on the bottom and top of pages 274 and 27

Central bank’s balance sheet consists of three types of assets and three types of liabilities-Assets: 1.Government of Canada bonds, 2.Foreign exchange, 3. Advances to the Chartered Bank, Liabilities: 1.Currency Outstanding, 2. Deposits of the chartered banks, 4. Deposits of the federal government

Government of Canada bonds- Canadian government sells bonds to the Bank of Canada which there is an exchange of money to the government by the bank which is promised to be repaid back and through the Bank of Canada the government sells bonds to individuals, businesses, institutions, etc.

Bonds: a financial asset that represents a debt owed by a corporation the holder, on which interest is paid by the corporation

Foreign Exchange-stock of foreign currencies used to defend the Canadian dollar on international money markets and these currencies are used to purchase Canadian dollars which props up the dollar’s price

Advances to the Chartered Banks-Bank lends money to chartered banks for investment purposes which interest is charged (the Bank rate) to borrowers

Currency Outstanding-consists of bank notes issued by the Bank or paper money in circulation

Deposits of the Chartered Banks-=balances held by chartered banks at the central bank for the purpose of settling debts

Deposits of the Federal Government- where the government deposits its revenues and make payments from the account for such expenses as paying employees

By shifting deposits or by buying and selling bonds the bank can lower/raise short term interest rates and speed up or slow down the growth of the money supply

**Suppose Canadian economy is in a recession and AD is below the level of full employment. The government will try to increase their spending and tax cuts to try and get AD to a level closer to full employment (figure 12.9 pg 277). As a result, the Bank of Canada will engage an easy money policy, by lowering interest rates and increasing money supply.

**Easy money policy of the bank will put into effect four different consequences, as it were, that basically end with a recession/in a recession

**Stage 1: bank shifts its government deposits to charters increasing their reserves. With extra reserves the charters are able to lend more and to attract more borrowers the bank lowers its interest rates.

**Stage 2: lower interest rates encourages consumers to borrow more money to spend on ‘big ticket items’ such as houses, cars, etc…as a result, businesses respond by borrowing more money to invest into new stock, equipment, etc…

**Stage 3: new borrowing by consumers and businesses increases money supply growth (through increased bank deposits and reserves), allowing the increased output to be purchased throughout the economy.

**Stage 4: the increased spending by consumers and business pushes AD from AD1 to AD2, thus creating an increase in GDP, thereby ending the recession and coming to a point near full employment (figure 12.10 page 277).

**Suppose the economy is suffering from a period of high inflation. The finance minister would use such things (fiscal measures) as tax increases or cuts in government spending to lower AD. As a result, the Bank of Canada will then enter a time of increased interest rates, reducing the amount of money growth (a ‘tight money policy’).

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