Master 5 Economic Concepts

In the consumer price index- for urban consumers (CPI-U) they compare two baskets of goods to determine the inflation or deflation.

Inflation is the rise in price of goods and services over a longer period of time.

Deflation is the fall in price of goods and services over a longer period of time.

Inflation

Causes of inflation

·Increase in money supply

·More demand than supply

Arguments for inflation

·You will consume now while it is cheaper

·You will invest more

·Your debt becomes cheaper

Argument against inflation

·People with a fixed income lose purchasing power

Deflation

Causes of deflation

·More supply than demand

Arguments for deflation

·Goods and services are cheaper

Argument against deflation

·You postpone consumption

·You stop investing

·Your debt becomes more expensive

A good definition of exchange rates is: how much domestic currency do I need to buy 1 unit of a foreign currency?

A currency can appreciate and depreciate.

·When the Euro appreciates compared to the USD we need less Euro’s to buy the same USD.

·When the Euro depreciates compared to the USD we need more Euro to buy that same 1 USD.

Three main groups demand currency:

1.Tourists

2.People who buy foreign goods and services

3.For investment purposes

The government of foreign government supplies currency.

·If they supply less money the currency will appreciate

·If they supply more money the currency will depreciate

When the Euro depreciates Europe will export more and therefore America will import more. As a result when the Euro depreciates the USD will appreciate. Europe as a result will import less and therefore America will export less.

We have to pay a prize for renting money. When we loan money from the bank they cannot use that money, meaning the bank has opportunity cost.

·We pay interest to the bank when we take a loan and the bank pays us interest when we deposit money in our savings account.

·A 5% interest rate over $1000 means we pay or receive $50 at the end of the year

We have to take inflation into account.

Real expected interest rate = Nominal rate – expected inflation rate

Real realized interest rate= Nominal rate – inflation rate

·When the demand of money increases the interest rate goes up

·When the demand of money decreases the interest rate goes down

·When the supply of money increases the interest rate goes down

·When the supply of money decreases the interest rate goes up

Compound interest rates are one of the most important ways to grow your pension. Example of compound interest rates.

You deposit $10.000 into your savings account with a 5% interest rate:

Year 1: $10.000 + $500

Year 2: $10.500 + $525

Year 3: $11.025 + 551.25

From making choices opportunity cost arise. Opportunity cost is the option you decide to not do. For example: you can buy a bike or a computer. If you decide to buy a bike the opportunity cost for buying that bike is a computer.

·The Production Possibilities Frontier (PPF) shows us how efficient a country an be with different production possibilities

·Opportunity cost often increase, we can see that in the bow shaped curve of the PPF graph