Economics 1301

1
Economics 1301

• Basic Issues in Economics

2
Administrative Detail

• Jim Holcomb
• BUSN 240
• 747-7787
• jholcomb_at_utep.edu
• Office Hours
• 130 300 PM M-R

3
Economics

• The study of how people use their limited
  resources to try to satisfy their unlimited
  desire
• Huh?

4
Human Misery

• 2/3 of the worlds population faces near
  starvation on a daily basis
• 1 in 10 infants die before their 1st birthday in
  Ethiopia, Pakistan, Tanzania versus less than 1
  in 100 in US
• Why?

5
Our Limited Means

• The most important concept in economics -
  Scarcity
• Scarcity means that there isnt enough of
  anything to satisfy the wants of everyone.
• Resources are scarce
• Resources are the ingredients of the process of
  producing goods and services

6
Resources

• Land
• Raw Materials
• Labor Resources
• People
• Capital Resources
• manufactured resources

7
Scarcity Forces Choices

• There just isnt enough money or time to do
  everything
• Alternatives must be considered

8
Choice Implies Cost

• Choice implies a tradeoff or sacrifice
• Cost is the sacrifice made to acquire something
• The Opportunity Cost of a choice is the best
  alternative given up after the choice is made

9
Opportunity Cost

• TANSTAAFL
• 2nd most important idea in economics
• The cost of NOT selecting the next best
  alternative

10
Opportunity Cost

• The cost of NOT selecting the next best
  alternative
• Dollar Cost
• Time Cost
• External Cost
• OC places the value on resources
• Price represents the OC

11
Choice Also Implies Competition

• When desires exceed resources, desires must
  compete for what is available
• Competition is a contest for command over scare
  resources

12
Net Advantage

• People choose their actions on the basis of
  expected benefits and expected costs to
  themselves (Net advantage)
• Their choices alter the net advantage of everyone
  else
• Events are the result of choices.
• The emphasis in on choice. People choose.

13
Social Cooperation

• Motives for behavior
• Self-Interest (not selfishness)
• prefer more to less
• A process of continual adjustment to changing net
  advantage

14
Choices Represented by a Model

• Model (also called a theory)
• simplification of reality
• observable behavior
• assumptions
• implications

15
Production Possibilities
bread

• Combinations of things that can be produced with
  the economys resources
• Choices
• Opportunity Cost
• Preferences
• Rules

Milk
16
Economic Systems

• Framework in which economic decisions are made
• Who produces how much for whom?
• Pure Market Economy
• Pure Command Economy
• Mixed Economy

17
Market Economy

• Private ownership of resources
• private property rights
• Decentralized decision-making
• Choices are left to private resource owners

18
Resource Allocation in a Market-Based Economy

• Buyers and sellers voluntarily agree to exchange
  goods and services
• But, the game does have rules
• Market structure

19
Markets Structure

• Sellers side (Supply)
• Buyers side (Demand)

20
Market Structure Sellers

• Number of firms in a market
• Competitive
• Monopoly
• In-between

21
Competitive Market

• Many buyers and sellers
• no one can control the price
• Identical products
• Price free to adjust
• No discrimination by buyers or sellers
• Very easy entry and exit from market

22
Monopoly

• Single seller
• No close substitute
• Protective barriers to entry

23
Imperfect Competition

• Relatively few firms
• Similar products
• relatively easy entry and exit

24
Markets Demand

• Quantities of a product that consumers are
  willing to purchase at various prices,
• Other things equal.
• Income
• preferences
• prices of other goods
• expectations about future prices

25
Law of Demand

• Given a choice, would you rather pay 10 or 50
  for a Coke?
• Other things equal, the higher the price of a
  good the lower is the quantity demanded
• The Case of the Confused Clerk

26
Demand Curve
27
A Technical (but important) Distinction

• Change in Quantity Demanded
• Movement Along a Demand Curve
• Caused by change in price
• Change in Demand
• Shift of Whole Demand Curve
• Caused by anything other than price

28
Change in Quantity Demanded

• Caused by a change in the price of good
• Shown by movement along a demand curve

P
A
B
D
Q
29
Change in Demand

• Caused by change in anything other than the price
  of the good
• Shown by shift of demand curve

30
Things Other Than Price?

• Change in Income
• Change in Prices of Related Goods
• Change in Tastes
• Change in Expectation
• Change in Numbers of Consumers

31
Markets Supply

• Quantity of a Product that Sellers are Willing to
  Sell at Various Prices, Other Things Equal
• Other Things?
• Cost of Production
• Sellers Expectations
• Number of Sellers

32
Supply Curve
33
Law of Supply

• The higher the price of a product, the larger
  will be the quantity supplied, other things being
  equal.

34
That Same Technical Distinction

• Change in Quantity Supplied
• Caused by a change in price of this good
• Movement along a supply curve
• Change in Supply
• Caused by anything other than price
• Shift of a supply curve

35
Change in Quantity Supplied

• Caused by change in price of this good
• Shown by movement along supply curve

P
B
A
Q
36
Change in Supply

• Caused by change in anything other than price
• Usually cost
• Shown by shift in Supply Curve

37
Economic Costs

• Long run v. Short run
• Fixed v. Variable
• Total, Average, and Marginal Costs

38
Market Supply Demand
39
Competitive Equilibrium Social Well-Being

• Equilibrium
• No one wants to change anything
• Quantity Demanded equals the Quantity Supplied

40
Equilibrium The Saga Continues

• Everyone is completely happy (in economic sense)
• Resource Owners
• Owners of Firms
• Consumers
• Intentions of buyers and seller coincide

41
Economic Nirvana

• At equilibrium, consumers feel that firms are
  using precisely the right number of resources in
  production of this good.
• Scarce resource are being used correctly, from
  societys point-of-view.

42
But How Does (or can) This Happen?

• Consider what happens if price is above the true
  but unknown equilibrium

43
Answer--Price Above Equilibrium

• Consumers decrease quantity demanded Not worth
  it
• Firms see unintended inventory accumulation
  stuff not selling
• Firms put stuff on SALE!!
• WHY?

44
Price Below Equilibrium

• Consumers rush to buy BARGAIN
• Stores sell out and order more
• New stuff arrives at higher price
• Buyers decrease quantity demanded

45
Equilibrating Process

• Resources move from low-valued uses to
  higher-valued uses as if guided by some
  invisible hand.
• When left alone, market forces tend to ensure
  social economic well-being.
• Always?

46
Always?

• Supply and Demand in free economies sometimes
  are not free
• Monopoly
• Regulation
• Government Intervention

47
THE STOCK MARKET

• This material is not is the text. Use the WSJ for
  much of the references

48
Stocks

• Stocks are pieces of corporate pie.
• When you buy stocks, or shares, you own a slice
  of the company
• A corporations stockholders all have equity in
  the company.
• Why do they buy stock?

49
Common Stock

• Ownership shares
• Sold initially by company then traded among
  investors
• Investors buy the shares expecting dividends
• AND, hope the price of the stock will go up

50
Why common stock?

• Corporations trade ownership and control to
  investors whose motive is dividends and profits
• In return, they get investment money to build or
  expand their business

51
Risky?

• Stock prices fall when company does not do well
• Why? How?
• Entire investment could be lost
• But, not more than that. Shareholders are not
  responsible for corporate debt.

52
Classes of Stock

• Firms may sell different classes of stock
• Classes?
• Preferred
• In a specific subsidiary
• specific investment purposes
• restrictions on ownership and trading
• Blue Chip Stocks
• Stocks of largest, consistently profitable

53
Stocks and Ownership

• Stockholders have the right to vote on major
  policy issues at stockholders meetings.
• Generally the more stock you own the more votes
• But some companies issue different classes of
  stock with different voting rights

54
Voting

• Corporations have annual shareholder meetings for
  voting
• In person, or
• by proxy
• Securities and Exchange Commission (SEC) monitors
  publicly traded corporations

55
The Value of a Share

• Can change at any moment
• market conditions
• investor perceptions
• phase of the moon, etc.
• Supply and Demand

56
The Value of Stock

• Aug 1982, IBM major player in PC, stock price
  rises 75 in one year
• After 1987 Crash price falls from 100 to 41 in
  less than 1 year
• 2000 - 109

57
Making Money with Stock

• Capital Gains
• Buy low, sell high
• minus taxes and commissions of course
• Timing is everything
• earnings, competitiveness, economy, etc
• Dividends
• portion of corporate profit paid out to investors

58
Making Money with Stocks

• Dividends (continued)
• Paid as dollar amount per share
• Amount fixed by BOD
• Usually only large, mature corporations pay
  dividends
• Newer firms need to retain and reinvest their
  earnings

59
Dividend Yield

• Percentage of purchase price returned in
  dividends each year
• Income Stocks
• stocks that regularly pay dividends
• Growth Stocks
• Stocks that pay little or no dividend but
  instead reinvest their profit

60
Stock Certificates

• Before the electronic age, companies prepared
  elaborate and ornate certificates of ownership
  called securities
• Today, the certificates have all but disappeared
  and only electronic records identify owners

61
From Private To Public Ownership

• An entrepreneur has an idea for a product and
  borrows enough money to launch the business
• As the company grows, the entrepreneur can get
  funds for expansion in the private equity market

62
Private Equity Market

• Sophisticated investors have assembled pools of
  money called venture capital that they are
  willing to risk in a new business in exchange for
  a role in how the company runs and a share of the
  profits

63
Going Public

• If the firm continues to grow and needs more
  money than venture capitalists can provide, it
  decides to go public
• The first time a company sells stock is called
  going public
• After that it can sell additional stock to raise
  money

64
Initial Public Offering (IPO)

• Company goes to investment bankers who buy the
  stock for resale to the public and large
  investors
• They also prepare prospectus, a detailed analysis
  of companys financial history
• They publicize sale with ad called tombstone

65
Investment Bankers

• The day before the actual sale the underwriters
  price the issue.
• Note that the company only gets money when the
  stocks are issued.
• Subsequent trading means profit or loss for the
  shareholder, but nothing for the firm.

66
Stock Buyers

• Individual Investors
• About 51 million Americans own stocks
• However, proportion of total stock held by
  individuals is dropping
• Institutional Investors
• Mutual Funds
• Insurance Companies
• Banks

67
Institutional Investors

• Majority of stocks held by institutions
• An institutional trade is in blocks of 10,000 or
  more shares
• Program Trading
• Trading by formula monitored by computers on
  automatic
• Large trades can and do influence the market
  (SD, again)

68
Buying Stocks

• Buy or sell through stockbroker at a brokerage
  house that is a member of a stock exchange
• Stocks generally sold in round lots of 100 shares
• Odd lots less than 100 shares, can be even 1 share

69
Broker

• Place order to buy with broker
• Broker charges a commission
• Types of order
• Market Order -- buy now at current price
• Limit Order -- buy when price falls to certain
  price
• Likewise, orders to sell placed with broker

70
Buying on Margin

• Set up margin account with broker.
• Then can borrow up to 50 of the price of stock
  from broker on the account
• Pay interest on the borrowed portion but dont
  repay principal until stock sold
• Sounds good but if stock price falls
• The Dreaded margin call

71
Reading Stock Tables

• High and Low Price
• Per Cent Yield (Dividend)
• Price/Earnings Ratio (P/E)
• Relationship between price of stock and companys
  earnings the past 4 quarters
• A P/E of, say, 14 means its price is 14 times its
  earnings per share (EPS)

72
Stock Tables

• Volume
• multiply number by 100 (unless you see a z)
• Cash Dividends (Div)
• estimated yearly dividend per share
• In WSJ, companies are listed by name then trading
  symbol

73
Still More Stock Tables

• Daily High, Low, and Close
• Net Change from previous close

74
Some Advanced Stuff

• Selling Short
• Selling something you dont own yet.
• Borrow shares from broker and sell them, wait for
  price to fall and buy shares to return to broker
  plus commission and interest.
• Investors do this when expect prices to fall

75
Some Stock Information

• Book Value
• Difference between companys assets and
  liabilities--low is generally bad
• Earnings Per Share (EPS)
• Divide number of shares into profit--going up is
  better

76
Stock Info

• Return on Equity (ROE)
• Divide EPS by Book Value
• Payout Ratio
• Percentage of net earning company uses to pay
  dividend--25-50 is normal--higher means firm is
  struggling to meet obligations
• Get information from annual reports

77
The Actual Stock Market

• NYSE AMEX -- Wall Street
• five regional exchanges also
• Role of SEC
• See investors are fully informed about securities
  offered for sale
• Prevent misrepresentations and fraud
• Monitor insider trading

78
Seat on the Exchange

• Memberships on exchange
• 1,366 on NYSE and 661 on AMEX
• The exchanges are actual marketplaces, i.e. malls
  for stock
• They do not set prices. Supply and Demand set
  prices

79
NASDAQ

• National Association of Security Dealers
  Automated Quotation system
• An electronic market
• Stocks sold over-the-counter (OTC) and not listed
  on exchange
• Usually smaller, emerging companies

80
Market Indices

• Average of market as a whole
• Dow Jones Industrial Average (DJIA) a.k.a. the
  Dow -- the oldest and most famous
• The market up 15 points today--they mean the
  Dow went up 15 points
• 30 component stocks
• about 25 of the total value of all stocks listed
  on NYSE
• firms picked by editors of WSJ

81
Other Indices

• NYSE Composite Index
• all NYSE stocks
• SP 500
• NASDAQ Composite

• Russell 2000
• 2000 small companies
• Wilshire 5000
• all stocks traded

82
What Makes Market Go Up?

• Ample money supply
• Tax cuts
• Low interest rates
• Political stability
• High employment

83
What Makes Market Go Down?

• Tight money
• Increased taxes
• High interest rates offering better return in
  less risky investments
• Political unrest
• International conflicts
• Upcoming elections

84
Mutual Funds

• Also not in the text

85
Mutual Fund

• Generally safer to own variety of stocks and
  bonds than to gamble on success of a few (form a
  portfolio)
• But, it is hard and expensive
• So, a collection of stocks, bonds, or other
  securities owned by a group of investors and
  managed by a professional investment company

86
Operating a Fund

• Funds are created by investment companies
• They decide on an investment concept
• What is their objective?
• Growth, income, specific industries
• Issue a prospectus
• Sell shares

87
How Funds Work

• A large number of people with money to invest buy
  shares in a mutual fund
• Their pooled money has more buying power
• The fund manager invests money in collection of
  securities
• Successful investment adds value to the fund

88
Fund Operation

• Investors receive distribution of earnings
• Income Distributions
• money fund earns on its investments
• Capital Gain Distributions
• Profit from selling investments
• Or, they can reinvest the money in the fund

89
Types of Funds

• Open-end funds
• Fund sells as many shares as investors want
• Most mutual funds are open-ended
• Closed-end funds
• Funds sells shares only once and offers only a
  fixed number of shares
• The shares often are traded on an exchange

90
Mutual Funds Market

• Funds diversify holdings in investments that
  correspond to their type fund
• A typical stock fund may own stock in 100 or more
  firms
• Some funds are extremely focused
• precious metal funds
• sector funds
• high yield bond funds

91
Fund Types

• Stock or Equity Funds
• Bond Funds
• Money Market Funds
• The first mutual fund was founded in 1924 by The
  Massachusetts Investors Trust (its still around,
  today called State Street Research)

92
Stock Funds

• Buy shares of stock in various companies
• Blue chips for income
• Growth stocks for future gains
• Value stocks for stability
• Cyclical stocks to take advantage of economic
  booms
• Some funds stress income, others growth, and
  others a combination

93
Bond Funds

• Two main categories
• Taxable
• corporate and U.S. government bonds
• Tax-free
• state and municipal bond distributions are
  federal tax free
• But, what is a bond?

94
Bonds

• Bonds are loans investors make to corporations
  and governments.
• The borrower promises to repay the loan at a
  specific time and to make annual interest
  payments over the life (term) of the loan

95
Bonds

• Bonds are originally sold at par (usually in
  units of 1,000) with a specified and fixed
  interest rate
• Investor like bonds for the steady income
• Bonds can be traded in exchanges (the secondary
  market)

96
Secondary Bond Market

• At a bonds resale, the current rate of interest
  may not be the same as the interest rate on the
  bond.
• If rates have gone down, the bond is worth more
  than its face value, and the bond is sold at a
  premium
• If rates are up, the bond is worth less and is
  sold at a discount

97
Bond Vocabulary

• Asset-backed
• Mortgaged-backed
• self-amortizing
• Agency

• Floating-rate
• Convertible
• Zero-coupon
• Callable
• Junk
• Savings

98
Bond Funds, again

• Many different types of funds
• Investment-grade corporate
• junk bonds
• Chief advantage is steady income
• And bonds are usually high face value and out of
  reach of individual investors

99
Money Market Funds

• Much like savings account
• Put dollar in, get dollar back, plus interest
• Invest in very short-term high grade securities
• Often, checks can be written against account
• Very little risk

100
The Risk Factor

• Volatility
• how much can return change in short term
• Predictability
• of overall returns
• Investment Objective
• The Risk/Return Tradeoff

101
Special Purpose Funds

• Index Funds
• track the market indices
• Tax-Free Funds
• Sector Funds
• Green Funds

102
Operating a Mutual Fund

• A fund has two businesses
• Making an investment profit
• providing services to its clients
• trading 150 million per day
• handling 15,000 pieces of mail per day
• Charge management fee and/or commission or load

103
Fund Quotations

• Net Asset Value (NAV)
• price of one share in fund
• Load
• front-end
• back-end

• 12b-1 fee
• management, marketing, and distribution fees
• Investment Objective