101 Things Everyone Should Know About Economics

From Securities and Derivatives to Interest Rates and Hedge Funds, the Basics of Economics and What They Mean for You

Peter Sander

• Publisher: Adams Media
• Year: 2013
• ISBN:
  9781440572722
• Topic: Economics
• Subtopic: Economic Theory
• Index: Economics

Economics, demystified!

From the collapse of housing prices to the thousand-point drops in the stock market, the past five years have been full of economic crises. These changes not only affect the overall market--they can also drastically influence your personal finances and day-to-day life. In this easy-to-understand guide, Peter Sander explains how the financial system works, as well as the most important concepts, terms, and programs in economics. Using simple language, he details how the evolving climate will affect world economies--and what kind of shifts you are going to see in your finances as a result.In this updated edition, Sander also includes valuable information on:

• The housing market and what it may do in the future
• The impact of Obamacare on the economy
• The scope of the Great Recession and how the U.S. is still struggling to recover
• How to take advantage of the economy as it begins to rise again

An essential guide, 101 Things Everyone Should Know about Economics, 2nd Edition helps you fully understand today's economy and shows you how to secure your financial future even as the market changes.

CHAPTER 1

The Basics

If you have taken an introductory economics course in college or have read a basic economics textbook, you can probably skip this chapter and go right to the next one. But if you want to refresh your grasp of basic economic terms, read on. Feel free, as you go through this book, to flip back to this chapter if you get confused by some of the terminology.

A GLOSSARY OF BASIC ECONOMIC TERMS

Asset. Something that is owned. For businesses, it can take the form of things such as factories, products, and equipment. Assets can also be intangibles such as patents, trademarks, and copyrights. These kinds of things often fall into the category of intellectual property, a concept that’s the subject of a growing body of law. In the age of the Internet, determining the value of an intangible asset has grown very complicated, and is probably going to become more so in the future.

Broker. Someone who sells or buys things on behalf of other people. For example, a mortgage broker buys and sells mortgages. An insurance broker arranges the sale of insurance policies to clients, and so on. The term brokerage firm usually refers to a company that deals in stocks. Brokers often make recommendations to their clients about what to buy and sell, but ultimately the buy-or-sell decision rests with the client.

Capital. Originally, this word described one of the factors used to produce goods (the others included things like land and labor). In today’s economy, “capital” generally refers to cash as well as to material goods like manufacturing equipment, tools, and so on. The term financial capital is used when talking about the monetary resources entrepreneurs use to create their products or services.

Competitive Advantage. It’s the nature of capitalism that businesses compete against one another. Each one tries to find some special way of beating its rivals, something that makes it stand out. That something is competitive advantage (also sometimes called the competitive edge). This is one of the most valuable tools a company has to ensure its growth, and companies try to protect their competitive advantages from all rivals.

Consumer. Anyone who uses goods and services that companies produce. Consumers have become a major driving force in the U.S. economy, and companies compete fiercely for their business. To this end, they spend a lot of time analyzing consumers, trying to figure out their buying patterns, their psychology, and so on.

Credit. Money that’s loaned to someone or something. Credit can be in the form of a mortgage, a car loan, a line of credit through a credit card, or any one of numerous other forms. When you have credit, that’s money that has been loaned to you by someone else. If you’re a creditor, you’ve loaned money to someone, and they’ll have to pay it back to you, usually with interest.

Debt. Something you owe to someone else. Personal debt has become a huge issue in the United States in recent years, and many people, as a result of their exploding debt, have suffered bankruptcies and foreclosures. However, some debt can be good—for example, if it’s used to buy something that will produce value (like a business asset) or increase in value over time (like certain real estate investments), or something that you need but will cost more in the future. Bad debt is when you purchase something you don’t need and can’t afford.

Elasticity. In the context of economics, the measure of the ability of an economy to change rapidly in response to circumstances. In a more technical sense, it’s the ratio between the percentage change in two variables (for example, supply and price). For instance, if the price of a product rises slightly and immediately the demand for it falls dramatically, the product is said to have high elasticity. The price of a product such as gasoline, on the other hand, can rise quite a lot before demand drops substantially, so it’s said to have low elasticity.

Entrepreneur. Someone who starts a business and takes responsibility for its success or failure. The term has also come to mean someone who shows enterprise, initiative, and daring in the business community. Even though many new businesses fail, we still respect those who are brave enough to follow their dreams. Small businesses, started and operated by entrepreneurs, represent 99 percent of all U.S. businesses, and for many they represent American capitalism in its purest form.

Forecast. An estimate of where the economy, a business, or some feature of either is going. Different government agencies, as well as nongovernmental organizations, make economic forecasts, some of which can affect the performance of the markets. Businesses use forecasts to plan their goals and budgets. Keep in mind, though, that a forecast is a guess. It’s usually an educated guess, but still a guess.

Free Enterprise. An economic system in which markets and companies are privately owned and are free to compete against one another with minimal government restrictions. This is the system that exists in the United States. It’s sometimes referred to as laissez-faire capitalism or free-market capitalism.

Innovation. The process by which companies come up with new products and services. Often, companies’ research and development (R&D) divisions take the lead in driving innovation. An innovation goes beyond an “invention” in that it becomes a product or service that people will buy—that is, there’s a market for it. Some companies (for example, Apple and Google) have built their competitive advantage on innovation—often with “disruptive” innovations that really change markets, in contrast to just adding refinements to existing products or services.

Interest. The fee paid in order to use borrowed money. Essentially, this is the cost of obtaining credit. Interest is calculated as a percentage of the amount borrowed. This percentage is called the interest rate. There are many different kinds of interest, including simple interest and compound interest. Interest rates are closely tied to credit risk, which is the risk that an extended credit—that is, a loan—will not be paid. In general, at a time of high credit risk, interest rates tend to go up, since creditors want to make sure they recoup their money. However, this isn’t always the case.

Investor. Someone who puts money into a business in order to earn a return—that is, to make more money. Sometimes investors do this by loaning money to the entrepreneurs who are starting or running the business. More often, they do it by purchasing stock—an ownership stake—in the business. The basic point to keep in mind is that investors want to earn a return. The percentage of money they make in relation to their investment is called their return on investment, or “ROI.”—see “Return on Investment.”

Macroeconomics. As implied by the term “macro,” the study of economics on a large scale: regional, national, or international economic trends and issues. Macroeconomists try to figure out what drives entire economic systems, and what impact these systems have on each other.

Microeconomics. Basically the opposite of macroeconomics. Microeconomics studies economic movement on a smaller scale—for individual businesses or even on the level of individual households. Microeconomists also study the behavior of companies and regions to understand how these units are allocating their resources and responding to pressures from above and below. A microeconomist might also study the behavior of a single product or product type.

Monopoly. A single company or individual controlling an entire product or service. In the nineteenth century, monopolies were fairly common in America (Standard Oil, for example). Throughout the late nineteenth and twentieth centuries, many of them were broken up by legislation, starting with the Sherman Antitrust Act of 1890. Today, government agencies review mergers in an attempt to prevent the formation of monopolies. In recent years, several monopoly-related cases have received a great deal of attention, most famously involving Microsoft, and have also entered the conversation with major wireless carriers, the oil industry, and other mergers.

Mortgage. The security for the money you owe to a lender. When you take out a mortgage, you borrow money and give the lender an interest in a property to secure the repayment of the debt. When you’ve satisfied the terms of the mortgage (that is, when you’ve paid the debt), the interest of the lender in your property will be returned to you. If you don’t repay the debt, the lender can foreclose on the property.

Outsourcing. The increasingly common practice of contracting people outside an organization to perform work that used to be done by people within a company. Outsourcing has grown massively to include everything from call centers and customer service to information technology services. Many American companies are outsourcing overseas to countries such as India, China, and Mexico, where labor costs and other costs of doing business are lower.

Publicly Held Company. A company that’s registered with the Securities and Exchange Commission and whose stock is traded on the open market, where it can be bought and sold by the public. In a privately held company, on the other hand, stock is held by a relatively small number of shareholders, who don’t trade it openly. Often these are family or friends of the owner. Eventually, the company may hold an initial public offering (IPO) and issue stock shares on the open market. After the company registers with the SEC, it becomes a public company.

Productivity. A measure of efficiency. It’s often expressed as the ratio of units to labor hours (a company produces two thousand pairs of shoes per hour, for example). Productivity is one element that’s factored into studies of economic growth. In general, industries try to increase productivity through technological innovation and other methods.

Profit Margin. A company’s net income divided by sales. It’s a basic measure of profitability, one that companies look at closely each year. Companies also look at metrics like revenue, but they aren’t considered as significant as profit margin. After all, a company can increase its revenue by selling more products, but if the production costs increase (for example, because of a rise in the price of raw materials or labor), the company isn’t really making any more money.

Return on Investment. A measure of how much money an investor gets back relative to the amount invested. It’s sometimes called the rate of return or the rate of profit. Many people make decisions about investment or other financial activities based on their calculation of ROI.

Venture Capital. Money that’s put into new businesses by outside investors. Venture capitalists tend to look for high-potential startup companies that can grow quickly and provide a strong return on investment. Family and friends who lend money for startups are sometimes referred to as angel capital. In some cases, venture capitalists anticipate that the company will grow to a certain stage and then be sold for a profit, and they’ll reap a rich reward. Alternately, the company may be successful in its initial public offering and see its stock rise dramatically in value. Many large companies such as Google and more recently Facebook started out this way.

CHAPTER 2

Economy and Economic Cycles

We start with the economy. Not a big surprise in a book titled 101 Things Everyone Should Know about Economics. By way of definition, the economy is a system to allocate scarce resources to provide the things we need. That system includes the production, distribution, consumption, and exchange of goods and services. It is about what we do as a society to support ourselves, and about how we exchange what we do to take advantage of our skills, land, labor, and capital.

Of course, that definition is a bit oversimplified. The economy is really a fabulously complicated mechanism that hums along at high speed—the speed of light with today’s technology—to facilitate production and consumption. The economy itself is fairly abstract, but touches us as individuals with things like income, consumption, savings, and i...