Classification of Classification of

Economic ConditionsEconomic Conditions

1

Prosperity

Employment rate and demand for products and services are high.

Recession

Unemployment rate is increasing and

demand for products and services are

lowering.

Depression

Unemployment rate is high and demand for products and services is lowering.

Recovery

Unemployment rate is lowering and demand for products and services is increasing.

2

YearYear 11 22 33

IncomeIncome

Income Income percent percent change change from year from year 11

$36,00$36,0000

n/an/a

$38,00$38,0000

5.6%5.6%

$21,00$21,0000

-42%-42%

Gallon of Gallon of milk costmilk cost

Gallon of Gallon of milk cost milk cost percent percent change change from year from year 11

$2.49$2.49

n/an/a

$2.99$2.99

20%20%

$3.19$3.19

28%28%

Over a three-year period, how has the

income been impacted by the

cost of a gallon of milk?

3

Consumer PricesConsumer Prices

Inflation Inflation Causes of inflationCauses of inflation Consumer Price Index (CPI) Consumer Price Index (CPI) DeflationDeflation Causes of deflationCauses of deflation

4

Measuring Economic Measuring Economic ActivityActivity

Inflation.Inflation. The rapid rise in prices caused by an The rapid rise in prices caused by an

inadequate supply of goods and inadequate supply of goods and services.services.

Total demand exceeds total supply.Total demand exceeds total supply. Dollars are plentiful, so their value Dollars are plentiful, so their value

declines and prices increasedeclines and prices increase The result is a decline in purchasing The result is a decline in purchasing

power; A dollar does not buy as much power; A dollar does not buy as much as it did before inflation.as it did before inflation.

Retirees and individuals on a fixed Retirees and individuals on a fixed income are financially hurt the most income are financially hurt the most because their income buys less.because their income buys less.

Inflation ReducesConsumers’ Ability to Buy

Goods and Services

As prices go up

Money does not buy as much

Consumers cut back on their spending

Benefits of InflationBenefits of Inflation Economists suggest that an inflation Economists suggest that an inflation

rate of 2-3% is healthy for the rate of 2-3% is healthy for the economy.economy. Wages rise more slowly than prices.Wages rise more slowly than prices. Producers make more profit and can hire Producers make more profit and can hire

more workers.more workers. Unemployment is lower.Unemployment is lower. Newly employed workers spend more Newly employed workers spend more

money and stimulate the economy.money and stimulate the economy. The United States usually has mild to The United States usually has mild to

moderate inflation.moderate inflation.

Disadvantages of InflationDisadvantages of Inflation

If you do not keep up with inflation, If you do not keep up with inflation, consumers will have a lower consumers will have a lower standard of living.standard of living. Inflation most affects people on a fixed Inflation most affects people on a fixed

income, retirees and the unemployed.income, retirees and the unemployed. Most workers are affected when inflation Most workers are affected when inflation

is at a moderate level.is at a moderate level.

Disadvantages of InflationDisadvantages of Inflation

Increasing inflation reduces the Increasing inflation reduces the consumers' ability to buy goods and consumers' ability to buy goods and services.services. Money does not buy as much (the value Money does not buy as much (the value

of the dollar goes down).of the dollar goes down). Consumers will purchase only necessary Consumers will purchase only necessary

goods.goods. Consumers will have to cut back on their Consumers will have to cut back on their

spendingspending

Disadvantages of InflationDisadvantages of Inflation Inflation occurs when there is too Inflation occurs when there is too

much money in the economy.much money in the economy. The government raises interest rates The government raises interest rates

to take money out of the economy.to take money out of the economy. Rising interest rates discourage Rising interest rates discourage

consumers and businesses from consumers and businesses from borrowing money.borrowing money.

Sales of durable goods fall.Sales of durable goods fall. Consumers "make do" with current Consumers "make do" with current

homes, cars, etc.homes, cars, etc. Business owners do not borrow to expand.Business owners do not borrow to expand.

Disadvantages of InflationDisadvantages of Inflation

Workers ask for higher wages; businesses Workers ask for higher wages; businesses raise prices to pay for the increases.raise prices to pay for the increases.

As consumers stop spending, business As consumers stop spending, business sales fall and owners must cut back.sales fall and owners must cut back. Some businesses have to layoff workersSome businesses have to layoff workers People who lose their jobs will be able to buy People who lose their jobs will be able to buy

fewer goods and servicesfewer goods and services Careful financial management is crucial in dealing Careful financial management is crucial in dealing

with inflation.with inflation.

Disadvantages of InflationDisadvantages of Inflation

Careful budgeting helps consumers Careful budgeting helps consumers cope with limited economic resources.cope with limited economic resources. Wise decision-making is also necessary to Wise decision-making is also necessary to

combat the effects of inflation.combat the effects of inflation. Comparison shopping, not impulse Comparison shopping, not impulse

buying.buying. Change lifestyle as needed.Change lifestyle as needed. Savings and investments must keep up Savings and investments must keep up

with or ahead of inflation so that the with or ahead of inflation so that the money saved does not lose value.money saved does not lose value.

Measuring Economic Measuring Economic ActivityActivity

Consumer Price Index (CPI).Consumer Price Index (CPI). A measure of the average change A measure of the average change

over time in the prices paid by over time in the prices paid by urban consumers for a market urban consumers for a market basket of 400 consumer goods and basket of 400 consumer goods and services:services: Food and beverage.Food and beverage. Housing.Housing. Apparel.Apparel. Transportation.Transportation. Medical Care.Medical Care. Education.Education.

Measuring Economic Measuring Economic ActivityActivity

Deflation:Deflation: A decrease in the volume, or amount, A decrease in the volume, or amount,

of currency so that there is less of currency so that there is less currency available for goods and currency available for goods and services within a free market; this services within a free market; this tends to force market prices lower.tends to force market prices lower.

Deflation occurs when too few dollars Deflation occurs when too few dollars are chasing too many goods. Scarce are chasing too many goods. Scarce dollars are worth more, so prices go dollars are worth more, so prices go down.down.

Interest RatesInterest Rates

Types:Types: Prime ratePrime rate Discount rateDiscount rate T-bill rateT-bill rate Treasury bond rateTreasury bond rate Mortgage rateMortgage rate Corporate bond rateCorporate bond rate Certificate of deposit rateCertificate of deposit rate

What is the primary purpose of each?

• How do interest rates impact businesses?

15

Prime RatePrime Rate The interest rate charged by banks to their The interest rate charged by banks to their

most creditworthy customers (usually the most creditworthy customers (usually the most prominent and stable business most prominent and stable business customers).customers).

The rate is almost always the same The rate is almost always the same amongst major banks. amongst major banks.

Adjustments to the prime rate are made Adjustments to the prime rate are made by banks at the same timeby banks at the same time

The prime rate does not adjust on any The prime rate does not adjust on any regular basis.  regular basis. 

The Prime Rate is usually adjusted at the The Prime Rate is usually adjusted at the same time and in correlation to the same time and in correlation to the adjustments of the Fed Funds Rate.  adjustments of the Fed Funds Rate. 

Discount RateDiscount Rate

The interest rate charged to commercial The interest rate charged to commercial banks and other depository institutions banks and other depository institutions

On loans they receive from their On loans they receive from their regional Federal Reserve Bank's lending regional Federal Reserve Bank's lending facility facility

Under the primary credit program, Under the primary credit program, loans are extended for a very short loans are extended for a very short term (usually overnight) term (usually overnight)

T-bill RateT-bill Rate

A short-term debt obligation backed by A short-term debt obligation backed by the U.S. government the U.S. government

Maturity of less than one year Maturity of less than one year Sold in denominations of $1,000 Sold in denominations of $1,000 Maximum purchase of $5 million Maximum purchase of $5 million Commonly have maturities Commonly have maturities

of one month (four weeks), three of one month (four weeks), three months (13 weeks) or six months (26 months (13 weeks) or six months (26 weeks). weeks).

Treasury Bond (T-Bond) Treasury Bond (T-Bond) RateRate A marketable, fixed-interest U.S. A marketable, fixed-interest U.S.

government debt security government debt security

Maturity of more than 10 years Maturity of more than 10 years

Make interest payments semi-annually Make interest payments semi-annually

The income that holders receive is only The income that holders receive is only taxed at the federal level taxed at the federal level

Treasury Bond (T-Bond) Treasury Bond (T-Bond) RateRate

Issued with a minimum denomination Issued with a minimum denomination of $1,000 of $1,000

Sold through auction Sold through auction

Mortgage rateMortgage rate

Interest rate on a loan secured by a Interest rate on a loan secured by a mortgage on a propertymortgage on a property

A Mortgage is a debt instrument that A Mortgage is a debt instrument that is secured by the collateral of is secured by the collateral of specified real estate property specified real estate property

Borrower is obliged to pay back with Borrower is obliged to pay back with a predetermined set of payments a predetermined set of payments

Corporate Bond RateCorporate Bond Rate

A debt security issued by a A debt security issued by a corporation and sold to investors corporation and sold to investors

The backing for the bond is usually The backing for the bond is usually the payment ability of the company the payment ability of the company typically money to be earned from typically money to be earned from

future operations future operations Considered higher risk than Considered higher risk than

government bonds government bonds

Corporate Bond RateCorporate Bond Rate

Interest rates are almost always Interest rates are almost always higher, even for top-flight credit higher, even for top-flight credit quality companies.  quality companies. 

Issued in blocks of $1,000 in par Issued in blocks of $1,000 in par value value

A major source of capital for many A major source of capital for many businesses businesses

Certificate of Deposit RateCertificate of Deposit Rate

A savings certificate entitling the A savings certificate entitling the bearer to receive interest. bearer to receive interest.

Bears a maturity date Bears a maturity date A specified fixed interest rate A specified fixed interest rate

Can be issued in any denomination Can be issued in any denomination Generally issued by commercial banks Generally issued by commercial banks

Insured by the FDIC Insured by the FDIC Ranges from one month to five years. Ranges from one month to five years.

Certificate of Deposit RateCertificate of Deposit Rate

It is a time deposit that restricts It is a time deposit that restricts holders from withdrawing funds on holders from withdrawing funds on demand. demand.

It is still possible to withdraw the It is still possible to withdraw the money, this action will often incur a money, this action will often incur a penalty.  penalty.