BUSINESS, FINANCE, AND ECONOMICS
Professor Day
Investing
1. What is common stock?
- It represents the residual ownership of the corporation.
- No guarantee you will make money.
- Most stock is common.
2. What is preferred stock?
- Traded by investors.
- Different from common because they have less risk and less reward.
- The amount of dividend if guaranteed, and paid before common stock.
3. What are stock splits?
- When prices reach a certain price the corporation can split the stock to lower the price.
- Two for one gives you two shares for everyone you owned.
- It affects the price of the stock and it also affects the stockholder- when the price goes up,
the stockholder has double the shares.
4. What is a reverse split?
- A corporation exchanges more shares for fewer, say 10 shares for 5, and the price
increases accordingly.
- The motive is to boost the price so that it meets a stock market’s minimum listing
requirement.
5. What is a proxy?
- A proxy is a legal document that presents information on planned changes in company
management that requires shareholders approval.
- They present shareholder proposals, identifies the nominees for the board, and list major
shareholders.
- Can vote of the proxy.
- Shows the total compensation of the company’s top 5 executives.
6. What is cumulative voting?
- You can combine you votes and cast different numbers of votes for different candidates.
- It gives small shareholders more voice in corporate governance.
- If you own 100 shares and 8 directors were running, you could give all 800 to one, or
divide tem up. Take the number of shares and multiple by the number of openings.
7. What are capital gains?
- The profit you make on the sale of stock.
- You must pay taxes on the gain and pay a commission to the broker.
8. What are cyclical stocks?
- Shares of companies that are highly dependent on the state of the economy.
- When things slowdown, their earnings typically fall and so does the stock price (airlines,
hotels, and gas company).
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9. What is the difference between income and growth stocks?
- The difference is that income stocks pay dividends, while growth stocks pay little or no
dividend while reinvesting their profit.
10.What is par value?
- Par value was once related to its investment value.
- Today the issuing company sets it, typically between 25 cents and $1 a share, strictly for
accounting purposes.
11. What is an initial public offering (IPO)?
- Going public, means making it possible for outside investors to buy the company’s stock.
- To go public, the management registers the stock with the Securities and Exchange
Commissioner (SEC) and makes an initial public offering.
- Investment bankers and entrepreneurs are involved.
12. What is the job of an investment banker?
- They underwrite the stock offering, that is, to buy all the public shares at a set price and
resell them to the general public.
- Underwriters help the company prepare a prospectus, a detailed analysis of the
company’s financial history, its products or services.
13. What is a secondary offering?
- If a company has already issued shares, but wants to raise additional capitol, or money,
through the sale of more stock.
- Typically done if stock price is too high.
- Most companies are wary of this, since the larger the supply of stock outstanding, the less
valuable each share already issued becomes.
14. Explain institutional investors?
- Institutional investors are organizations that invest it’s own assets or those it holds in trust
for others.
- Are investment companies- including mutual funds, pension systems, insurance
companies.
- A buy or sell order must be 10,000 shares or more to be considered an institutional trade.
15. Explain the process of buying and selling stocks?
- To buy or sell you usually go through a brokerage house. A stockbroker handles your
deal.
- (1) Customer places an order to buy or sell, (2) brokerage firm handles your transaction,
and (3) stock market reflects activity.
16. Who regulates the buying and selling of stocks?
- SEC (Securities and Exchange Commission).
17. What is selling short?
- To sell short, you borrow shares you don’t own from your broker, order them sold and
pocket the money.
- Then you wait for the price to drop. If it does, you buy the shares at the lower price, and
turn them over to your broker and keep the difference.
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- If the price goes up you lose because price to but back is higher than the borrowed shares.
18. What is buying of margin?
- When buying on margin you set up a margin account with a broker, sign a margin
agreement, and maintain a minimum balance.
- Then you can borrow up to 50% of the stocks price and buy with combined funds.
- It is related to leveraging which is investing with money borrowed at a fixed rate in hope
of earning a greater rate of return.
- Margin call is when an investment falls below a required minimum, you must meet the
call by adding money or sell.
19. How do you read a stock table?
- High/low: for the past 52 weeks, more volatile, the more you can make.
- Percent yield: how much dividend you get as a % of the current price.
- Price/earning ratio (P/E) shows the relationship between stocks price and the company’s
earnings for the last 4 quarters (divide current price by earnings per share).
- Volume: number of shares (multiple by 100) traded the previous day (z indicates the
actual number).
- Cash dividends: anticipated yearly dividend per share in dollars.
- Hi/Lo close and Net change.
20. What is the book value of stock?
- The difference between the company’s assets and liabilities.
- A small or low book value from too much debt means that the company’s profits will be
limited even if it does lots of business.
21. What are earnings per share?
- Earnings per share are calculated by dividing the company’s net profit by the number of
its outstanding shares.
- If earnings increase each year, the company is growing.
22. How can you obtain information about a company?
- Companies provide annual and quarterly reports to keep investors informed.
23. How does the Amex American Stock Exchange) differ from the New York Stock
exchange?
- AMEX is considerably smaller than the NYSE, but operates essentially the same.
- Listing standards are lower and many listed companies are smaller and the securities are
priced lower.
- It is common for a company to start on the AMEX and later move to the NYSE.
24. What is the over the counter market?
- Large number of brokers and dealers who make deals via computer or telephone, buying
and selling for themselves and customers.
- All belong to organization National Association of Securities Dealer (NASD).
25. What are specialist and why are they important?
- Maintain inventories of shares they are responsible for and to buy when the market is
declining or to sell when the market is rising to assure smooth trading pattern, avoids
artificial fluctuations.
- The objective is to let the market find its proper level.
- Without them, we would see wild fluctuations in the price of stocks.
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26. What are market orders?
- Market orders are orders to execute the transaction, either to buy or to sell, at the market
price in effect at the time the order reaches the floor.
27. What are limit orders?
- Limit orders direct the broker to buy or sell at a specified price rather than at whatever
price the stock is currently trading at.
- When a stock hits the price, priority goes to first on list for that price.
- Orders are given to a specialist.
28. What is a day order?
- A day order is a limit order that requests a certain price or better but in any event to buy
the stock at the end of the day
29. What is a stop order?
- A stop order is an order to sell when the price has declined to a particular point, sell when
it has increased to a certain point.
30. What is a margin transaction and how does it work?
- A margin transaction involves borrowing money from one’s broker usually in order to
enable an investor to buy more shares of marketable securities.
- The Fed. Reserve Board regulates: (1) an investor can borrow no more than 50% of cost
of purchase, and (2) NYSE requires an additional margin when the value declines to the
point where the investor’s shares represents 25% of the value.
31. What is a margin call?
- A margin call is when the value on the margin transaction has declined to a certain level
(30 to 35%)
- A margin call is made on the value of the entire portfolio and not on each individual
stock.
32. What is the role of the Fed Reserve Board in regulating margins?
- Fed Reserve Board regulates margins by setting a limit on the borrowing margin (no
more that 50%).
- Brokers are protected with margin calls, although often advise to sell earlier (30-35%).
33. What is selling short and how does it work?
- Short selling is when an investor borrows shares from is broker and orders them sold.
- When the price declines, the short seller buys the shares back at the lower price.
- He replaces the shares he borrowed and pockets the difference.
- He must provide 50% of the value of the stock. So if the borrowed shares are $10,000,
he must put in $5,000.
34. What are some of the problems of selling short?
- The risk is when someone seeks to obtain a corner on the outstanding shares so that it
becomes hard for the seller to find shares to buy back to cover.
- Can depress a security’s price to unrealistically low levels in an already declining market.
35. How does over the counter operate and what are some of its characteristics?
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- Consist of a large number of brokers and dealers who deal with each other by computer
or telephone, buying and selling securities for them and their customers.
- Dealers: a securities firm trading for its own account, while a broker executes for a
customer
- Spread: Difference between market maker is willing to buy or sell.
- Bid prices: What the dealer is willing to pay.
- Asked prices: What is willing to sell for.
36. The OTC deals primarily in what type of securities?
- Marketable debt securities, corporate bonds, treasures, municipals, convertibles,
mortgage backed securities, and equities.
37. What is the NASDAQ?
- The NASDAQ is the computerized quotation system at the heart of the modern OTC
market.
- Three levels of quotes:
- (1) Level I: Provides representation bid and asked quotations that enable a person to get a
feel for the market.
- (2) Level II: Provides access o actual quotations by every market maker in each security
listed.
- (3) Level III: Allows market makers to input the machine and enter or change quotations.
38. What is the closing tick?
- The closing tick is the number of advancing stocks minus the number of declining stocks.
39. What is the role of stock market indexes or averages?
- It measures the general level of stock market prices over time.
40. What does the Dow Jones average attempt to measure?
- Dow Jones average is actually four different averages: (1) 30 industrial companies; (2) 20
transportation stocks; (3) 15 utilities; and (4) and composite average of the 65 stocks.
41. Why would the Dow Jones average increase while the broader based indexes decreased?
- Dow could go up if the narrow base of stocks represented in the average increased while
the rest of the market went down.
42. What do the S&P and NYSE indexes measure?
- S&P (Measures 500 stocks) and NYSE (1632 companies) are true indexes as they
measure changes in total market value of the stocks that make up the index, and the index
number is the % change compared with a base period.
43. Why are there many different indexes?
- There are different indexes because they are more reflective of what is happening.
- Psychological value of the Dow may make it the most important.
44. What does the Fed. Reserve do?
- They are the guardian of the nation’s money. It act as a banker, regulator, controller, and
watchdog.
- 12 separate district banks.
- Shapes the economy, stabilizes the country’s chaotic financial system.
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- Maintains the money in circulation.
45. What are other forms of money?
- Checks, debit and credit cards, ATM cards, and electronic transfers (moving money
among your accounts).
46. How does the money cycle work?
- First the treasury ships new money to the Fed Reserve Bank
- Fed Branches distribute the new money to individual banks, exchange for old bills and
coins.
- The banks distribute the money to its customers.
- The money circulates through the economy and around the world.
- The banks separate old worn down money that is deposited, and ships to Fed,
- The fed branch returns old money to treasure where the no good bill are shredded and the
coins are melted down.
47. What is inflation?
- When there is lots of money in circulation, prices go up and money buys less.
48. How is the money flow controlled?
- A committee meets every six weeks to evaluate the economy.
- It tells the Reserve whether to speed up or slow down the creation of new money.
- Next, NY fed decides whether to buy or sell government securities in order to implement
the open market committee’s policy.
49. What is the money supply?
- (1) M1: Narrow money, includes all money in immediately spendable forms- cash and
money in checking accounts (Smallest of the 3).
- (2) M2: Broad money, includes M1, but adds savings and money in small time deposits
(like CDs), it easily converted.
- (3) M3: The broadest, it includes both M1 and M2, plus assets and liabilities of financial
institutions, including long-term deposits, which can’t be easily converted into spendable
money.
50. How do we measure economic health?
- Unemployment figures: falling number is a sign that the economy is growing, create fear
of inflation because too much money in circulation.
- Index of leading economic indicators: released monthly, durable goods, housing starts,
and new factory orders.
- 3 consecutive rises in the index is considered to be that the economy is growing.
- 3 drops means it is in a potential decline.
51. What are blue chips?
- Refer to the stocks of the largest most consistently profitable corporations.
52. What are capital gains?
- The profit from the sale of a capital asset, such as securities or a home.
53. What are dividends?
- The portion of the company’s profit paid out to it shareholders. Board of directors
decides how large a divided the company will pay.
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54. What is a prospectus?
- A detailed analysis of the company’s financial history, its products or services, and
managements background and experience.
55. What is the difference between a broker, dealer, and trader?
- A broker buys and sells orders placed by individual and institutional clients for
commission.
- Dealers buy and sell securities for their own accounts or firm’s account.
- Traders buy and sell or their own portfolios.
56. What are savings bonds?
- Bonds are issued in face amounts denominations ranging from 50 to 10,000 and are sold
at half their value.
- Interest accrues until the bond is redeemed and no tax has ro be paid until it is redeemed.
57. Explain the accounting cycle?
- (1) Transactions are analyzed from source documents
- (2) Transactions are recorded in a journal
- (3) Entries are posted to a ledger
- (4) Accounts are adjusted at the end of period to achieve adjusted trial balance
- (5) Financial statements are prepared from the adjusted trial balance
- (6) Accounts are closed to conclude current accounting period and prepare for beginning
of accounting period.
58. What is inflation?
- When there’s a lot of money in circulation, prices go up and paper money buys less.
- It affects the economy in that it takes more money to buy something. The dollar doesn’t
have value as it did before.
59. What is the function of the Fed Reserve system and how does it work?
- It acts as a monitor; monitors all the banks in its system.
60. What is the discount rate?
- The interest the Fed Reserve charges its banks for the loans.
- Increase discount rate equals less borrowing by a bank, which means less lending by this
same bank.
- Decrease discount rate equals borrowing by bank, more money to lend out.
61. How is the money supply measured?
- Economists and policy makers keep track of the public money by measuring M1, M2,
and M3.
62. How does the consumer’s attitude affect the economy?
- If they feel good about their current situation and about the future, they spend more
freely, which boost
63. What is the consumer price index (CPI)?
- Serves a dual role of reflecting economic trend economic growth.
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- If they are worried about things like job security, they tend to save more and spend less,
slowing growth and the economy itself.
- and influencing economic policy decisions. Reflects what it cost to pay for food,
housing.
- It is calculated by recording prices of 80,000 goods and services that reflect the current
lifestyle of the typical urban American consumer food, clothing, transportation,
recreation, education.
64. Explain the economic (business) cycle?
- First demand increases, which make prices, increase. When demand decreases, prices
decrease (recession). Cycle begins again.
- Demand increases- more people want something than are available= seller can demand
more money.
- Price increases- people demand higher wages to get the item, so the cost to build the
items increase.
- Demand decreases- people can’t afford the item, so it decreases. People buy less.
65. What is a recession?
- Recession is a long-term slow down, 2 consecutive quarters in which the economy
shrinks in a recession.
66. What are the consequences of an unchecked economic cycle?
- It would lead to a worldwide depression like the one that followed the stock market crash
of 1929.
67. How does the Fed influence the economic cycle?
- By creating new money to make borrowing easier.
- As a economy picks-up, sellers sense a rising demand for their products and begin to
raise prices.
- Must be careful, it can lead to inflation.
68. What factors help influence the value of a nation’s currency?
- If shifting wildly, indication that economy may be in turmoil (default on loans).
- Political environment can impact value, threats of war, civil unrest. In time of unrest, the
dollar is looked at as a pillar of strength.
- If big demand is high for our currency, the value increases. If low, it decreases.
69. How is foreign currency measured and valued against the dollar?
- Look to its value in the market place look at the country’s economy.
- Our currency is backed by our word, not the gold standard.
- The strong dollar equals more buying power.
70. What are the fundamental characteristics of common share stock?
- Entitled to vote for the election of directors and other matters coming before the
shareholders.
- Also, entitled to the net assets of the corporation.
71. Differences between a closely held corporations and publicly held corporations?
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- Closely held doesn’t have to disclose current information about their activities.
- Closely held has fewer shareholders than does a publicly held corporation.
- Closely held doesn’t have an outside market, publicly does.
72. What are the characteristics of a closely held corporation?
- Number of shareholders is small.
- No outside market for its shares.
- All or most of its principal shareholders participant in management.
- The free transferability of shares is restricted by agreement. This creates a risk of being
alienated by the other shareholders without a remedy.
73. What are the roles of shareholders in a publicly held corporations?
- They elect the board of directors, who manages the corporation.
74. Typically, who manages the daily operations of a publicly held corporation?
- Board of directors selects corporate officers to execute the decisions of the board of
directors and conduct the business on a day-to-day basis.
- Ultimate power is in the hands of the board of directors.
75. Why are institutional investors important?
- Control the price of the market.
- Their major role is to collect and invest primarily in publicly held corporations, they on
nearly 50% of all shares issues by the 1000 largest corporation.
76. How are classes of stocks created?
- Classes of stocks are created by provisions in the article of incorporation of the
corporation.
77. Why do corporation choose to classify stock?
- To govern the control relationships between two or more shareholders- such classes are
usually designated by alphabetical notations.
- Class A common, class B common, etc.
- Used more in closely held corporations than in publicly held corporations.
78. What is a stock option?
- A stock option granted to senior management are common incentive compensation
device designed to align the interests of managers with those of shareholders.
- Usually granted at a lower price than the market price of the common share.
79. What are warrants and or rights?
- These are options that may be publicly traded and listed on securities exchange.
- The owner of a warrant or right has fewer rights, not voting right or rights to dividend or
distributions before the option is exercised.
- Issued as a sweetener in connection with the distribution of a debt or preferred stock
issue.
80. Explain intrinsic value and time value.
- The value of a warrant or right may be divided into two components: (1) Intrinsic value
and (2) time value.
- For example, a $12 warrant when the stock is selling at $10 per share has no intrinsic
value, but has some time value.
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- When the underlying stock is selling at $14 per share, the warrant has an intrinsic value
of $2 per share as well as a time value.
81. What are earnings per share?
- Earnings per share equal net earnings divided by the number of shares outstanding at the
end of the reporting period.
82. What are aggregate earnings per share?
-
83. Describe the similarities and differences between distributions and dividends?
- Distribution refers to any kind of payment (in cash, property, or obligations of
indebtedness) by the corporation to one or more shareholders.
- Dividend is a narrower term referring to a special type of distribution- a payment to
shareholders by the corporation out of its current or retained earnings.
84. How do statutes control the payment of distributions and dividends?
- A capital protection provision that prohibits distributions, which in some sense invade or
reduce the permanent capital or the corporation; and
- A provision prohibiting distributions that have the effect rendering the corporation
insolvent in the sense of being unable to meet its obligations as they mature.
85. What is a dividend yield?
- The dividend yield of a stock is the announced dividend by the price of the stock.
86. What is a payout ratio?
- Payout ratio is the dividend as a percentage of earning per share.
Bonds: Things to Know
1. What are bonds and how do corporations and governments use them?
- Bonds are loans that investors make to corporations and government. The lenders earn
interest, and the borrowers get the cash they need.
- Bonds pay interest over a fixed term, or period of time. When the bond matures at the
end of the term, the principal, or investment is repaid to the lender, or owner of the bond.
Usually purchased for half the face value.
- The rate is usually fixed at the time the bond is offered (fixed income securities).
- Interest accrues until the bond is redeemed…. Up to 30 years (long-term bond).
- No interest paid, no tax due until the bond is redeemed.
- Not a good choice for investors who may need to ―cash out‖ since bonds cannot be
redeemed for a minimum period of 6 months.
- Used by corporations to raise money to invest in growth and development. Prefer bonds
over more stock because issuing more stock dilutes the value of shares already owned.
Also provides some tax advantages.
- Used by Government to raise money, since governments are not profit making
enterprises. Used to raise money for improvements on roads and airports.
- Issued in $1,000 denominations.
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2. Describe several methods of making money in the bond market?
- Conservative investors use bonds to provide a steady income.
- Bonds that are issued when interests rates are high become increasingly valuable when
interest rates fall. That’s because investors are willing to pay more than the face value of
a bond with an 8% interest rate if the current rate is 5%.
- More aggressive investors trade bonds, or buy and sell as they might with stocks, hoping
to make money by selling a bond for more than they paid for it.
- Bonds are risky because of there is a chance for rising inflation. Since the dollar amount
you earn on that investment doesn’t change, the value of that money can be eroded by
inflation.
3. Calculate the yield of a bond: When purchased as a discount. At a premium?
- How to figure a bond’s yield: Annual interest rate divided by the price = Yield. For
example $60 divided by $1000 = .06 or 6%.
- At a discount rate: Market value + Interest paid each year (X number of years held) –
the original cost = Loss. For example $800 + 120 (8% interest per year, held for two
years) - $1000 for original cost= $80 loss.
- At a premium: Market value + Interest paid each year (x number of years held) –
Original cost = Return. For example $1200 + 180 (held for 3 years at 3%)- 1000 for
original cost = 380 return.
4. What is the significance of yield to maturity?
- It is a precise measure of bonds value.
- It takes into account: (1) the interest rate in relation to the price; (2) the purchase price
in relation to the part value; (3) The years remaining until the bind matures.
- Yield maturity is a way to predict return over time.
5. What is the significance of bond rating? What are junk bonds.
- Investors want to know the risks in buying a bond before they take the plunge. Rating
services measure those risks.
- The best-known services are Standard & Poor’s and Moddy’s investor services.
- Moody’s Aaa and Standard and Poor’s AAA are the best quality ratings, with the
smallest risk.
- - These rankings influence the interest rate an issuer must pay to attract investors.
Typically, the higher the bond’s rating, the lower the interest it pays and the lower its
yield.
- Junk bonds: are the lowest-rated corporate bonds. There is a great chance that the issuer
will fail to repay its debt. Yield is much higher because if the risks involved.
6. Describe a Treasury auction of T-bills.
- Every Monday institutional investors submit to the Federal Reserve bank bids stating
how much less than 10K they would pay
- Individual investors submit a check for the amount to but X’s 10k.
- - Treasury department accepts bids beginning with those closest to 10k until quota is
filled, this raises the most revenue with the least amount of debt.
- Treasury announces cut-off, then computes average of bids and sells to noncompetitive
bidders for that price.
- Refunds to investor the difference between par value and price paid when the bill
matures, buyer gets back full value.
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7. What investment strategy uses municipals?
- The municipal bond is not taxed by the federal government, but may be subject to the
alternative minimum tax.
- - Usually appeal to investors in the higher tax brackets, where the exemption can provide
the biggest tax savings.
- - If you live in the state you purchased the bond from, it may be tax exempt.
8. What does 89 1/8 represent?
- Bond prices are quoted in increments of points and eight fractions of a point.
- Par value of $1000. Each point is worth $10, and each fraction is worth $1.25.
- Thus, 89 1/8 is: 89 * $10= $890 + 1.25 = $891.25.
9. What does 101:3 represent?
- Represents the bid and asked price.
- For example, the bond paying 12 3/8 that matures in May 2004 had a bid price of 134:14
and an asked price of 134:20. The :20 in the price refers to 20/32 of a point, or $6.25 and
:14 to 14/32 or %4.38. So the bid price was 1344.38 and the asked price was $1346.25.
- Each 1/32 equals 31.25 cents.
- Each point is still worth $10.
- So 101:3 would equal: 101 * $10 = 1010 + (31.25 * 3) =1010.94 (rounded up).
10. What is the coupon yield of a treasury offering?
- Dollar return on T-bill Divided by the cost of T-bill = coupon equivalent yield.
- For example: $40 divided by $960 = 4.16%.
- - This tells the investor what s/he will make on a t-bill. It gives the percentage return.
11. What are mortgaged backed securities? Describe how they work? What are the
benefits and drawbacks of investing in them?
- Mortgage backed bonds are backed by a pool of mortgage loans. They’re sold to
brokers by government agencies and private corporations, and the brokers resell them to
investors.
- They are self amortizing, which means each payment you get includes both principal and
interest, so that there is no lump-sum repayment at maturity
- The benefits: almost no default risk and high yield because of high real estate mortgages.
- The disadvantages: Hard to judge the prepayment of call risk, e.g., if interest rates drop
then people refinance driving interest rate of security down.
12. Explain the relationship between the stock and bonds markets.
- Two relationships exist: (1) If interest rates are down usually good for the stock market,
not so good for bonds; (2) corporations can issue both stocks and bonds to finance
themselves.
13. What are convertible bonds and how might investors use them?
- Convertible bonds give you the option to convert, or change, corporate bonds into
company stock instead of getting cash repayment.
- The terms are set at issue. They include the date the conversion can be made, and how
much stock each bond can be exchanged for.
- The conversion option lets the issuer offer a lower initial interest rate, and makes the
bond price less sensitive than conventional bonds to changes in the interest rate.
- Good to do if stock is paying more dividends than bond is paying yield.
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Mutual Funds
1. What are mutual funds?
- Mutual funds are a collection stocks, bonds or other securities owned by a group of
investors and managed by a professional investment company. These professional
managers keep constant tabs on the markets, trying to adjust the portfolio for the
strongest possible performance.
2. What are the benefits of investing in mutual funds?
- Mutual funds pool people’s money together to create much greater buying power than
you would have investing on your own.
- Since a fund can own 100s of different securities, its success isn’t dependent on how one
or two holdings do.
- Mutual funds offer diversity of stocks.
3. How are mutual funds created, sold, and managed?
- Mutual funds are created by investment companies (called mutual fund companies),
brokerage houses and banks.
- In doing this, a mutual fund company decides on an investment concept, then it issues a
prospectus, and finally it sells shares.
- Mutual funds are appealing to investors because they offer diversity with little capital.
- They are marketed to potential investors with ads in the financial press, through direct
mailings and press announcements.
- They are managed by a professional manager who keeps track of the market, trying to
adjust the portfolio for the strongest possible performance.
4. Explain the difference between open-ended and close-ended funds.
- Open-ended funds: this means the fund sells as many shares as investors want. As
money comes in, the fund grows. If investors want to sell, the fund buys back the shares.
- Sometimes open-ended funds are closed to new investors when they grow too large to be
managed effectively- though current shareholders can continue to invest money.
- Closed-ended funds: Resemble stocks in the way they are traded.
- Closed-ended funds do invest in a number of securities, but they raise money only once
and offer only a fixed number of shares that are traded on an exchange or over the
counter.
- Closed-ended funds prices fluctuate in response to investor demand as well as to changes
in the value of its holdings.
5. Explain what types of funds can be used for: Growth, current income, and income and
growth.
- Growth: (1) Sector- Stocks in particular industry, such as energy or transportation; (2)
Emerging markets- Stocks in companies in developing countries; (3) Value funds-
Stocks in companies whose prices are lower than they seem to be worth.
- Current income: (1) Short/intermediate-term debt- Different types of debt issues, with
varying maturities, depending on type of fund; (2) High-yield bond- Low rated and
unrated corporate and government bonds.
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- Income and Growth: Balanced- Part stocks and preferred stocks (usually 60%) and part
bonds (40%); (2) Equity income- Blue chip stocks and utilities that pay high dividends.
6. Special purpose funds include: Index funds, tax free funds, sector funds, and green and
other conscience funds?
- Index funds: designed to produce the same return that you would get if you owned all
the stocks in a particular index (ex. S&P 500). They are popular because it can eliminate
having to decide among specific stock or bond funds. It can also provide a balance to
other investments.
- Tax free funds: Mutual fund that pays tax free dividends. Appealing to those in the
highest tax brackets, since they might come out ahead at tax time. Provide lower yields
than taxable funds. Biggest tax saving is found in a state that issues bonds because they
are free from federal tax and state tax. Can also get a triple savings if you buy from a
municipality. Hard to find enough high-quality investments to meet investor demands.
- Sector funds: Focus on a particular industry or segment of the economy, such as
technology, health care or financial services. In this sense they are out of step with
mutual funds; diversity. If the sector is bad, the whole fund may be bad.
- Green and other Conscience funds: Attracts investors who have strong political beliefs
that make them unwilling to invest in companies whose business practices are at odds
with their beliefs.
7. You should be able to read the financial pages and glean such important data as: NAV,
NAV change, load and no load, total return, rankings, and E.
- NAV: is the funds net asset value. A fund’s NAV is the dollar value of one share in the
fund, and the price a fund pays you per share when you sell. It’s figured by totaling the
value of all the fund’s holdings and dividing by the number of shares.
- NAV change: Difference between today and previous day.
- Load: A charge when you buy shares. Loads are a percentage of the investment amount
and may be charged when you buy, when you sell or throughout the period you own the
fund (Usually class A funds).
- No load: If 0.00 appears, the fund is no load. No commission, investors pay NAV for
each share they buy.
- Total return: Is the percentage of gain(=) or loss (-) the fund has provided, assuming all
distributions have been reinvested.
- Rankings: R is for longest period listed under total return. A is top 20% while E is
bottom 20%. If NS, ranking fund didn’t exist at the beginning of the period.
8. You should know that prospectus give information regarding: Management, objectives,
distribution, redemption, deferred sales load, reinvestment and exchange fees, turnover
rates, minimum investment, investment options, and redemption options.How to read a
financial report
1. What is included as a corporate asset in a financial report?
- Balance sheet: Snapshot in time. Information on assets and liabilities.
- Assets: includes all goods and property owned and claims against others to be collected.
Things that will be turned into cash within a year from the balance sheet date.
- Current assets: Within a year enough to pay bills, but too much makes it a target for
takeover. Marketable securities, account receivable, inventories, prepaid expenses, total
property, plant equipment (depreciated).
(a) Why should property, plants, and equipment be included as an asset in a company’s
financial report?
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- Because they are items that the company owns and can be liquidated.
(b) Why is some property depreciated and other property not?
- Some items are not subject to depreciation because it doesn’t have a decline in useful
value due to normal wear and tear, e.g. land
- Intangibles, depends on company- patents, copyrights, and good-will.
2. What is included as a corporate liability in a financial report?
- Current liabilities (w/in 12 months)- accounts payable, notes payable, accrued
expenses, income taxes. Long-term liabilities (due after one year)- deferred income
taxes, debentures payable.
3. What does shareholder’s equity represent?
- This item is the total interest that all shareholders have in this corporation. In other
words, it is the corporation’s net worth or its assets after subtracting all of its liabilities.
- Corporations can’t sell for less than par. If stock goes up while selling, the company
takes the money as paid-in capital.
4. What are retained earnings?
- Retained earnings are the accumulated profits the company earns and reinvests or
―retain‖ in the company.
5. What can I learn from a balance sheet?
(a) What does a company’s net working capital figure tell me about the organization?
- Difference between total current assets and total current liabilities. Should maintain
comfortable amount and should be larger than last year.
- Remember, current liabilities are debts due within one year of the balance sheet date.
- Current assets represent the amount of current assets that is left if all current debts are
paid.
(b) What does the current ratio represent?
- To interpret the current position of a company being considered as a possible investment,
the current ratio may be more useful than the dollar total of working capital. You must
compare the current assets figure to the total current liabilities. A current ratio of 2 to 1 is
adequate. This means that for every $1 of current liability, there are $2 in current assets.
- To find the current ratio, divide current assets by current liabilities. For example-
Current assets of $405,800 divided by current liabilities of $176,000, which equals 2.31
over 1 or 2.3 to 1. Thus, for every $1 of current liabilities, there are $2.31 in current
assets.
(c) What does the debt to equity ratio tell us about a company?
- It is an indicator of whether the company is using debt excessively. Too much debt is a
sign for investors to be cautious.
- The debt-to-equity ratio is computed as follows: Total liabilities divided by the total
shareholder’s equity. For example total liabilities is $322,00 divided by $346,050 = .93
- This means the company is using 93 cents of liabilities for every dollar of shareholder’s
equity in the business. Try to keep it under a 1 to 1 ratio.
6. What can I learn from a company’s income statement?
- Can be thought of like a motion picture, since it reports on how a company performed
during the periods presented and shows whether that company’s operations have resulted
in a profit or loss.
- The income statement shows the record of a company’s operating results for the whole
year.
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- It also serves as a valuable guide in anticipating how the company may do in the future.
- The costs incurred usually consist of cost of sales, selling, general and administrative
expenses, such as wages and salaries, rent, supplies and depreciation.
7. What do I learn from a company’s earning per share?
- The earnings are important because they usually influence stock market prices.
8. What does a high or a low price to earnings ratio mean?
- Calculate by market price divided by earnings per share= price earning ratio.
- High in comparison to similar companies means investor confidence.
- Low means no investor confidence.
9. What does a company’s return on equity tell me about the organization?
- ROE: Seeing how hard money works, of course, is one of the most popular measures that
investors use to come up with individual judgments on how much they think a certain
stock ought to be worth.
- ROE shows how hard shareholders’ equity is working.
- To arrive at the figure, an investor looks at the balance sheet and computes the average
shareholders’ equity for the year to calculate how much was made.
10.REMEMBER: evaluate a company over time, not what it did in the last year or two.
Basic Economics
1. What are factors of production? Why are they important?
- The factors of production are land, labor, capital and owners equity.
- They are important because the scarcity of these resources is what drives our economy
via the market system.
- There were no factors of production before capitalism.
2. What impact does technology have on an economic system?
- An increase in technology increases the ability to produce at higher levels of output.
- Increased technology expands the production possibility frontier.
- Technology helped break down the complicated tasks of productive activity into smaller
subtasks…division of labor.
3. Describe Adam Smith’s economic model?
- Adam Smith believed that markets are good.
- He believed that in individual choice and freedom of exchange.
- He believed that the market will arrange for the production of the goods that society
wants, in the quantities society wants, without anyone ever issuing an order of any kind-
invisible hand.
(a) How is it Smith’s model still present in modern society?
- Still present today because the US economy is still basically an open economy.
(b) Where does Smith’s model fail?
- Smith’s model fails in the respect that it lends itself to unequal wealth distribution and
may create negative externalities.
- Smith saw technology as a way to reduce the amount of labor required, that it promotes
competition, and drive the demand for increased production of goods.
- Smith saw how technology spurred growth
4. Describe Karl Marx’s economic theory?
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- Marx’s saw history as a continuing struggle among social classes, ruling classes
contending with ruled classes in every era.
- Marx saw tension and antagonism as the outcome of the class struggle, and the setting of
capitalist society as anything but permanent.
- Marx saw an exploitation of labor.
- He also saw the market as a powerful force in the accumulation of capital and wealth.
(a) How does Marx’s model manifest itself in today’s world?
- It manifest itself today in the form of labor unions and collective bargaining to control the
exploitation of the labor force.
- The social structure will be reduced into two classes- a small group of capitalists
magnates and a large mass of proletarianized (propertyless) workers- class struggle.
(b) What are the downfalls to Marx’s economic model?
- A downfall is that his model is not incentive based and may lead to economic stagnation.
- He saw profit as coming from the value of labor, thus the combines were an exploitation
of the capital producing resources (few were benefiting).
5. Describe John Keynes’ economic theory?
- Keynes thought the government should take an active role in the economy via taxing and
spending (fiscal policy).
- He is the father of the idea of a ―mixed economy‖ in which government plays a crucial
role.
- - The overall level of economic activity in a capitalist system was determined by the
willingness of its entrepreneurs to make capital investments.
(a) How is Keynesian economics presented in modern society?
- Active today because the government will spend money to pull the economy out of a
recession.
- Keynes felt that laisses-faire was not the appropriate policy for capitalism.
(b) What are the failings of Keynes’ model?
- A downfall to fiscal policy is that it doesn’t react quick enough and could become over
regulatory which could be detrimental to the market.
6. Characterize the present day U.S. economic system. Is it a combination of these three
theorists? Does it follow one model more closely than another? What are the failings of the
US economic system?
- Our current economic system has elements of all three models, but more closely
resembles the Keynesian and Smith version.
- The economy has provided many choices to consumers as to the products and services
individuals may choose from.
- This has been accomplished via the market mechanism.
- Some have argued, however, that the economy has created great disparities in wealth and
some have argued that our market system is biased toward white males.
7. What institutions make up the economy?
- Small business is the employer of a substantial fraction of the nation’s labor force.
- 80% of the corporations in the world do less than 1 million worth of business a year.
- If we take only the biggest 100 firms, we find that they are the source of almost half the
sales of the entire industrial sector.
- Households are the source of the labor force.
(a) What role does government play in the economy?
- Government doesn’t just mean the federal government…federal government has a crucial
role in the economy as many levels.
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- The state and local governments are much more important than the federal government as
a source of employment.
- The variety of public outputs reminds us that government is not a dead weight on the
economy- ex. Public schools, public roads, public hospitals, etc.
8. What is the GNP?
- GNP means the gross national product.
- GNP equals investment and consumption and government spending and net exports.
- GNP does not take into account transfer payments.
- Real GNP adjusts growth for inflation.
- Measures output of goods and services and investments in capital goods and government
and business.
- In the 1980’s takeovers took place and capital was not reinvested into productive venues.
Therefore, GNP declined. Furthermore, conglomerate mergers from 1960’s began to fall
in 1980’s. Conglomerate mergers equal inefficiency.
- From 1900 to 1960’s there was a wave of mergers that increased the GNP.
9. Why did the economy shift from individual enterprises to large corporate ventures?
- The economy has shifted to large corporate ventures because large corporations are able
to achieve economies of scale and can make products cheaper and faster than individual
enterprises.
(a) What are economies of scale?
- Economies of scale means that a company can produce as such a volume to get cheaper
inputs because they can buy those inputs at a bulk rate.
(b) Why are they important?
- This is important because cheaper inputs will likely enable the firm to sell their product at
a lower price than the individual enterprise.
10. Why has the government’s role in the economy increased over the several decades?
- The growing size of business itself has evoked a need for government intervention.
- Also, the government’s role has increased because society felt that the need to provide
more wealth transfers to try to even out some of the wealth distribution created through
the market system.
- The government has also grown in its regulatory capacity and its capital investment
capacity.
Friedman argues that government has grown because it hires people during recessionary times too
late and doesn’t lay them off when the economy heats up again.Macroeconomics
1. What is the difference between GNP and GDP?
- GDP (gross domestic product) measures the value of output that includes all the goods
and services produced by the public sector as well as those produced by the private
sector.
- GNP (gross national product) Measure output of all us citizens.
- GNP is the value of all goods, services and government investments owned by
individuals in the U.S. and investments made in the U.S. by foreign firms.
2. What does GNP measure? What are the components of GNP?
- GNP measures output of goods and services and investments in capital goods by
government and business.
- GNP is composed of personal consumption + private domestic investment + government
purchases + net exports (shows total output).
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3. What information does GNP give us?
4. What are transfer payments and why are they not included in GNP?
- Transfer payments are payments to individuals for which no current goods or services are
exchanged (Social security, welfare).
- Not included in GNP calculation because GNP increases the production of our economy
that is based on the exchange of goods and services.
- Because no direct production takes place for transfer payments, such as a social security
check, they are simply left out when we calculate.
5. What is the relationship between savings and investment?
- The relationship between savings and investment is important because the savings pool is
used for capital investment for business.
6. How does GNP grow by employing savings?
- Theoretically, savings equals investment; therefore, a lower savings rate means a lower
capital investment rate and subsequently slower growth.
7. What are sources of principal sources of investment for business?
- The money it takes in from sales. Business sector spends more than it saves.
- Also buys and sells stocks and bonds, and borrows money from banks, IPO’s, annual
earnings (internal growth) equity, and business expansion.
8. Explain how government’s capital investments can influence economic growth?
- Government capital can influence growth because it may decide to invest in the defense
industry or road construction or any number of things that could spur job growth and
economic prosperity.
- On the other hand, government may also decide it doesn’t need to do this, thus slowing
down the economy.
9. What is the relationship between consumption and investment in thch is predictable and
investment in United States economy?
- Household and other savings are acquired by business sector to finance the building of
new capital goods. In turn, spending on investment goods becomes primary means by
which we increase productivity and therefore cause GDP to increase.
- In a standard economic model, income is either consumed or saved. Since saving equals
investment, the more that people decide to consume, the less investment will occur. We
are a consumption oriented/credit based economy.
10. What is the relationship between consumption that is predictable and investment in
capital goods? Why is investment so unpredictable and risky?
- Predicting investment may be difficult because capital investment relies on the demand
for the products that the capital produces. Predicting this demand is difficult because
people’s tastes and preferences change over time.
11. How does investment in the stock market or in a savings account relate to the kind of
investment economists refer to?
- Investment in the stock market or savings accounts makes, with other like investors, a
pool of money from which businesses can borrow to invest in capital expenditures (i.e.
new machinery for the plant).
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12. The world economy has experienced several periods of transformational growth since
1700. Explain what technologies gave rise to these periods of transformational growth and
how transformational growth affected economies.
- The factory system made possible having a whole household of different goods that
formerly could only have been made by the wealthy.
- Railroads led to standardize time zones and the possibility of allowing cities to grow as
large as NY, etc., because food could be supplied to that many people.
- Electricity, autos, etc., had the same kind of effects. Computers, planes, bio-tech,
creation of jobs and opportunities.
- Government had a great deal of involvement with railroads, air travel, computers, etc.
13. If the United States were in a steep recession or depression, what economic program
might be proposed by Adam Smith, karl Marx, Alfred Keynes? How might these programs
work?
- Smith would advocate the use of market mechanism to eventually pull us out.
- Keynes would advocate government spending to spur the economy to grow.
- Marx would probably unite the unemployed workers to revolt and take over industries
and work for communal purposes.
14. Many economists believe the federal government can safely run deficits because: The
debt is owed to us
The governments earning power is linked to the entire economy which is
immense
The deficit would vanish if the federal budget were divided into a capital
budget and an operating budget (similar to industry)
Critique these beliefs:
- The debt is not completely owned by the U.S. Some of it is owned by foreign interest—
about 15%.
15. Explain how the government’s management of the deficit and the national debt may
“crowd out” other investments.
- The borrowing necessitated by deficit financing makes it more difficult for investors and
consumers to obtain loans.
- With fewer funds available, they are less able to acquire output.
- Their share of the nation’s output is thus crowded out by an expanding public sector.
- If government is borrowing money for debt, it can’t invest that in industry.
16. Since the great depression, the federal government has played an activist role in the
economy. It has tried to smooth the business cycle through “demand management.”
Explain how demand management works.
- Demand management (fiscal policy) involves the process of taxing and spending to
control business cycles.
- During a recession, government may use spending power to spur the economy and it may
raise taxes to slow the economy down.
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17. Is the modern government’s role in the economy inflationary? Can the government add
growth to the GNP?
- The government’s role in the economy could be inflationary because when they spend
money on projects, people are put to work, wages are made and people will generally
have more money to spend on consumption.
- Hence, prices will likely rise with the increased demand for goods and services.
18. Explain how the government uses the Federal Reserve System to manage the economy?
- (1) Regulate bank margins- lend more.
- (2)Discount rate loans to banks, encourages banks to alter interest rates
- (3) Open market operations- buy bonds in market, more money fed holds bonds and then
sells.
- Feds. Can affect the money supply by requiring banks to maintain a certain amount of
money on reserve (regulating reserves).
- Setting the discount rate on loans to member banks.
- Regulating the amount of government securities outstanding, which is part of regulating
the monetary supply.
- Fiscal Policy—using taxation powers to get more money; extending unemployment
benefits, health care during a recession.
- Friedman’s theory is that the growth rate should not be messed with, other than to keep
growth rate at some target number.
19. Explain supply side economics.
- Only private sector is capable of increasing national output on a lasting basis.
- Supply side policy is the use of tax rates, deregulation, and other mechanisms to increase
the ability and willingness to produce goods and services.
- Pump money into the economy to help supply side.
- Demand side—cut taxes so (?) spend more money.
20. Milton Friedman has little faith in demand management or the monetary policies of the
Federal Reserve Banking System. Friedman believes the path to growth is monetarism.
Explain monetarism and contrast it with the Fed’s policies and the fiscal policies of demand
management.
- Friedman thought Fed. Would never get supply of money right because they don’t know
real state of the economy at any given moment. Supply money when they should be
reining it in. Supply of money should be expanded by an unchanging fixed % geared to
long term growth of nation’s output.
- Friedman’s monetarism would set a targeted growth rate for the economy and the money
supply would be adjusted to meet that goal.
- Different from the Fed. Because the Fed. Does not have a target.
- Different from fiscal policy because fiscal policy advocates government spending to
increase the money supply to ―prime the pump.‖
21. Why does inflation occur when there is full employment and increasing demand?
- Inflation occurs with full employment and increasing demand because in order for
employers to find qualified workers in a tight labor market, they must raise wages.
- This rise in wages puts more money in the hands of consumers and must be accounted for
in the price of products (unless employer is willing to accept less profit).
- Increasing demand for products will also give rise to higher prices if supply remains
constant.
- Quite simply, if people have more money to spend, inflation goes up.
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22. What went wrong with President Johnson’s “guns and butter” policy during his
Administration? Why did it lead to inflation? Had you been President, how would you
have financed the Viet Nam War, maintained strong domestic consumption, and financed
the War on Poverty, the Great Society and other social programs?
23. Before 1950, the classic enemy of American prosperity was depression and recession.
Since the 1960’s, the enemy of prosperity has been inflation. What is responsible for the
shift in concern to inflation?
- So many safeguards against depression, all we have to worry about is inflation.
24. What has made the modern American economy more prone to inflation than
depression?
25. Explain how inflation may be caused by perverse behavior by consumers and business.
- Prices start to rise; people buy more because they will think prices will continue to rise.
Increased buying, increases demand.
26. How does ratcheting up occur in our economy?
- Wages and prices go up but rarely come down.
- Concentrated business and union power, coupled with horror of competition.
- Prices and wages generally move up.
27. What were some of the causes of stagflation and runaway inflation of the 1970s? What
brought this inflation under control? Explain how the high dollar of the 1980s helped to
bring inflation under control.
- The main cause of high inflation in the 1970s was due to oil shocks.
- The high dollar in the early 80s helped curb inflation because the high dollar made U.S.
products more expensive in foreign markets, therefore, demand for those products
dropped and prices and prices dropped to meet the demand level.
28. The “social contract” method of Western Europe, the Japanese bonus system, wage and
price controls, and tight money are all methods used to control inflation. Explain how these
concepts work and evaluate their advantages and disadvantages.
29. Recently, American productivity has lagged behind our major trading partners. How
have major changes in the nature of our economy, our savings rate, and our method of
economic organization (big unions, big government, big business) contributed to the
slowdown in growth?Assignment 12
1. How does the market system work?
- The market economy is an economy that relies on markets for basic decisions about what
to produce, how to produce it, and for whom to produce.
- This is accomplished by millions of individuals making decisions based on their tastes
and preferences, which sets a market price.
2. Explain what economist mean by demand.
- How much we spend for an item at its price and how much we are willing to spend.
- The ability and willingness to buy specific quantities of a good at alternative prices in a
given time period. Represented by the demand curve.
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3. Using a chart with a supply curve and demand curve show market equilibrium. Assume
that your model was of the auto industry and consumers had more money to spend on cars.
Show how this demand changes affects consumption and production. Your model is still the
auto industry, consumer demand remains constant, yet costs of auto production has risen
dramatically. Show these changes on your chart and explain behavior.
4. Explain how markets ration goods.
- Markets ration goods by setting clearing prices at market equilibrium.
- The quantity of a good is rationed to the extent that consumers demand it and suppliers
supply it.
- Surplus and shortage goods are not equilibriumed priced.
5. Sometimes there are “shortages” in a market economy such as housing for low-income
families. Sometimes there are “surpluses,” such as wheat. How does government’s decision
and programs contribute to these shortage and surpluses? Use supply and demand curve
charts to illustrate your analysis.
- Housing shortage—supply is not large enough that housing is fair for the poor, so
government will get involved to build houses and bring the supply up.
- Wheat surplus—government pays extra for wheat so that it can give it for school lunches,
etc., thus the farmers are willing to grow more because they can get more than the market
will pay.
6. Market systems are considered efficient by most economists. In what ways are they
efficient? How do market economies differ from traditional economies or command system
economies?
- Market economies are efficient for the most part because competition forces the highest
quantity (and quality) of products to be produced as a given price.
- Market economies differ in that individual consumers make choices as to how many and
what price goods are to be sold. This is different than the government choosing, what,
when and how to produce—as a command system.
7. Why is consumer ignorance often found in market economies? How can advertising and
government regulation (labeling or banning) overcome consumer ignorance?
- Consumer is likely because there are so many products and services available on the
market that there is no way that consumers’ can be educated on all products.
- Advertising and government regulation may help to educate the consumer.
8. What role do “perverse expectations” play in market economies?
- If consumers have perverse expectations that the economy is going to do well, consumers
may be willing to pay higher prices and supplier may withhold goods hoping to drive
prices higher.
- When prices go up, consumers think they will keep increasing, so all rush in to buy.
Demand goes up, supply goes down- recipe for skyrocketing prices.
9. What are public goods? Why can’t the market be relied upon to produce them?
- They are not consumable like other goods (lighthouses, national defense, etc) and
therefore hard to price, and if you could predict the price it would probably mean that you
have a command society.
- National defense and weather services are tough to price because it is hard to figure out
who the users are, who should be taxed, etc.
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- Police protection, courts, etc., could conceivably be privatized functions where only those
who used them paid for them.
10. What are externalities?
- Effects on production of private goods/services on persons who aren’t buying or selling
the goods in question.
- Cost (or benefits) of a market activity borne by a third party (i.e., pollution).
11. Explain how regulations, taxation, and subsidies may be employed to curtail
externalities. What are the benefits and drawbacks of each approach?
- Example, pollution is sometimes cheaper than passing the costs of cleaning onto the
consumers.
- Regulation is one way to deal with the problem (scrubbers on smokestacks).
- Others are bounties encouraging people to do the right thing (i.e., deposits on bottles,
etc.).
- Regulation drawback= increased prices for goods from the factory creating the
externalities.
- Taxation drawback= increased taxes, therefore, less disposable income.
- Subsidy drawback= creates a incentive not to produce.
12. If the externality was air pollution caused by a generating plant, what are some of the
externalities? Would prescribe regulation, taxation or subsidy to curtail the pollution?
- Air and water pollution, subsidy best way. Pay polluters to stop pollution.
- Passing laws seeks to impose a cost on polluters. The cost is passed on to the consumer,
which leads to lower demand and less employment.
13. How might a subsidy be used to stop highway littering?
- Give rewards for people who stop polluting.
14. Are our great businesses monopolies or oligopolies? Explain the difference in each
structure.
- They are oligopolies. In a monopoly, a single firm produces the entire market supply of a
particular good or service.
- An oligopoly is a market in which few firms produced all or most of a good or service.
Fewer sellers provide the bulk of the business.
15. Huge businesses have economic and cultural benefits was well as drawbacks. Describe
how these advantages and disadvantages manifest themselves in such areas as product
differentiation and advertising, economies of scale, corporation profits, wages, personnel
benefits, and research and development funding when contrasted with the classically
competitive industries.
- Successful enterprises raise prices and further increase profits. Big business attempts to
reserve competition
- In an imperfectly competitive market, advertising seems to make each product unique.
Advertising serves to educate consumers.
16. Great economic power is seen by many as a political problem. How would Milton
Friedman address the concern? A government antitrust lawyer? A government regulator?
- Friedman: economic power is derived from individual’s freedom to choose. The market
should prevail.
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- Antitrust lawyer: would attempt to stop any one company in gaining too much market
power.
- Government regulator: Would impose regulations on business to stop them from gaining
too much power. Would also regulate the political process so no firm could sway
decision makers to much.
17. Are American wealth and economic differences largely the product of the market
economy? What is the relationship of marginal productivity to income and wealth?
- Yes. People get back from society what they put in.
- Income reflects the marginal productivity of different contributors to the economic
process. Individuals receive income that reflect value of their work. Skilled workers
make more money than unskilled.
- Also good and bad luck- being with right company.
18. Why doesn’t the average American grow wealthy via “savings”?
- In microeconomic theory, people get wealthy by saving not consuming and earning
interest on savings.
- Some make money by not consuming, but most don’t make enough money to save and
earn interest. Most people consume what they earn.
19. Show how the capitalization of a successful small business creates wealth for the
entrepreneur. Assume that the entrepreneur had $100,000 in family savings and good idea.
She sold the bank on it with a business plan showing net profits of $100,000 per year and
the bank lent $900,000. Several years later she is posting $300,000 in profits and the
business has been appraised at 3 million. How has her wealth increased? Why?
- $100,000 (investment) + $900,000 (loan) = $1 million.
- $300,000 divided by 10% = $ 3 million.
- Her wealth has increased by $2 million in capital gain if she sells the business and the
200 k per year income.
- If she sells the business and pays back the loan she still nets over a million dollars. This
was done by leveraging her money (100 K) to get a loan to create the higher profits and
an increased appraisal value.
20. What should we do about the nation’s income distribution? Is it a problem?
Yes. Some say we should leave it as it is to encourage saving, therefore creating an investment
boom.Accounting Questions
Accounting is a system of conveying financial information to decision makers: management.
Accounting cycle: (1) transactions are analyzed from source documents; (2) transactions are
recorded in a journal; (3) entries are posted to a ledger; (4) Accounts are adjusted at end of period
to achieve adjusted trial balances; (5) financial statements are prepared from the adjusted trial
balance; and (6) accounts are closed to conclude current accounting period and prepare for
beginning of new accounting period.
1. What is the importance of financial accounting for a company?
- Prepared primarily for investors: Widely publicized and used and relied upon by
creditors, regulatory agencies, employees and others.
- Accounting involves entering of records of transactions as they occur and the subsequent
determination and reporting of result of operations on a periodic basis for investors,
creditors, regulatory agencies, and employees.
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- Comparability of the reports with the same company’s reports for earlier periods and with
published reports of other companies in the same or different industries is important.
- Accounting is also essential to ensure that business always has the proper inventory of
raw materials and finished goods on hand.
2. How does management accounting differ from financial accounting?
- Financial accounting: Used by everyone, e.g., financial statements for public (picture of
financial health for public).
- Financial accounting is the preparation of public reports using standard accounting
practices (GAAP) to ensure honesty and comparability of results.
- Management accounting: Done only for management. Allow informed decisions.
Business alternatives, strategies.
- Management accounting is for internal purposes (board of directors, managers, etc.), is
not publicly available, and usually not conducted in accordance with GAAP standards.
3. What is equity?
- Net worth (difference between assets and liabilities).
- Equity = assets – liabilities. Equity means ownership or net worth in this question.
4. Describe double entry accounting.
- Two entries for each business or financial transaction.
- Based on a restatement of the above equation: Asset = liabilities + equity.
- Assets must always equal liabilities. Thus, the left side of the equation (balance sheet)
must have entries balancing the right side, resulting in double entries.
(a) What are the underlying assumptions in financial accounting?
- (1) Business is a entity; (2) all entries have to be in the terms of dollars; (3) balance sheet
has to balance (assets = liabilities + capital- often outstanding shares), (4) every
transaction recorded in at least two places if balance sheet is to continue to balance.
5. How are income, profit, or losses reflected in the double entry bookkeeping system?
- Profit/loss and income statements are the same.
- Income = revenue – expenses.
- Are a right handed entry on the balance sheet.
- A profit and loss or income statement (t account) can be prepared in which income=
revenue- expenses.
6. What is a debit? Credit?
- Debit: a left hand entry (always the assets). Increases left hand balance sheet while
reducing right hand entries.
- Credit: a right hand entry (always the liability/equity). Reduces left hand entries, while
increasing right hand entries.
- Basically, revenue items are credits and expense items are debits.
- A debit journal entry increases left hand items on the balance sheet and decreases right
hand items while a credit journal entry reduces left hand items and increases right hand
items.
7. What are ledger accounts used for in a business?
- A ledger is a separate page for each important balance sheet and income statement. In T
shape.
- Tells a business where its cash account stands at any given time, also allows mechanical
basis to record routine transactions.
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- They are used as separate ledger sheets for each of the important balance sheet and
income statement entries, where debits are kept on the left of the T and credits are entered
on the right side.
8. Describe the items that make up the current assets of a company.
- Cash-funds on deposit in a checking account and cash equivalents.
- Marketable securities: excess cash that is invested, more long term.
- Accounts receivable: money from customers, subtract money for bad debts.
- Inventories: goods needed for production of end product.
- Current assets consist of cash plus other assets that normally may be expected to be
turned into cash within a year (sometimes longer).
- Cash includes not only funds on deposit in checking accounts, but also cash equivalents
(T-bills, CDs, money market accounts, etc.).
- Marketable securities are excess or idle cash available for periods of time that may be
temporarily invested in longer-term securities.
- Accounts receivable are amounts due from customers not represented by promissory
notes (often includes am allowance for bad debts or doubtful collection).
- Inventories include several types of goods needed by the business in production of its end
product: raw materials, partially finished goods in process of manufacture, and finished
goods ready for shipment.
9. Describe the items that are considered noncurrent assets.
- Fixed assets: property, plant, and equipment. Depreciated over time.
- Prepayments and deferred charges.
- Intangible assets: patents, trademarks, and franchises.
- Non-current assets: Consist of all assets that are classified as current.
- Fixed assets: are defined as property, plant, and equipment (usually recorded at historical
cost; plant and equipment are depreciated over their expected lifetime).
- Intangible assets: patents, trademarks, franchises, goodwill, capitalized research and
development costs.
- Other assets: debts owed to the company that mature in more than one year, minority
interests in independent businesses that the company plans to retain indefinitely, and the
like.
10. What are liabilities?
- Liabilities are obligations that probably will have to be paid in an amount that can
reasonably be estimated at the time the balance sheet is prepared.
- Current liabilities: expected to be satisfied out of current assets (usually w/in 1 year).
Account payable.
- Notes payable: due to banks and others within 1 year.
- Accrued expenses payable: catchall for other business creditors.
- Long-term liabilities: liabilities due more than a year from the date of the balance sheet.
11. What makes up the stockholder’s equity?
- Consists of two parts: (1) permanent capitalization of business; (2) retained earnings.
- For partnerships or proprietorships: called owners’ equity or capital or capital contributed
by owners.
- Preferred stock: usually has prior (but limited) claim to distributions ahead of common
shares.
- Common stock: represents residual ownership of the corporation.
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- Par Value: is often assigned to the stock (arbitrary amount). Usually par value issue
higher than the par value.
- Stockholder’s equity: is the balancing factor between assets and liabilities on the balance
sheet and consists of two parts (1) the permanent capitalization of the business and (2)
retained earnings.
12. What are the differences between accrual accounting systems and cash based
accounting?
- Cash method: (used by individuals) recognize transactions when cash comes in or goes
out. Cash does not recognize the actual doing of the work or committing to pay for it.
Easy to manipulate. Not a good representation of current status.
- Accrual: recognize transactions when they have their economic impact, not necessarily
when cash is received or disbursed, e.g., only recognize inventory asset when sales are
made from it. Not as easy to manipulate. Allows better picture of inventory of company.
Tries to match expenses and income when they occur.
- The basic difference is when transactions are recognized and taken into the accounting
system- the cash method is based on the convention that transaction should be recognized
when cash comes in or goes out. The accrual system works on the basis that transactions
should be recognized and taken into the accounting system when they have their primary
economic impact, not necessarily when the cash is received or disbursed.
- The cash system can lead to erratic results and be subject to manipulation where
inventory is kept, it ignores the most significant event in the transaction, which is usually
doing the work or committing oneself to pay for something that is actually used
immediately, but paid for later.
13. What is the purpose of the accrual system?
- The purpose of the accrual system: match expenses with corresponding revenues
wherever possible. Indirect expenses usually have to be accrued over time independent
of revenues, e.g., interest on borrowed funds or rent that must be paid on land that is
temporarily idle but will be used for business purposes.
- The goal of the accrual system is the matching of expenses with corresponding revenues
wherever that is possible, however, a variety of indirect expenses can’t be allocated to
specific revenues, and these items are accrued over time independent of revenues.
14. What types of businesses should use accrual accounting systems?
- Accrual accounting works best for businesses having large numbers of profit making or
loss creating transactions during each accounting period, e.g., airplane manufacturer.
15. What is straight-line depreciation?
- Take the difference between the original cost and scrap value and then divide by the
number of years of the truck’s estimated useful life.
- For example- Cost of truck is $3000, life of truck is 5 years, scrap value of the truck in 5
years is zero. Then $3000 divided by 5 equals $600 per year.
- Equal reduction of the asset per year over the useful life of the asset.
16. What actual economic effects does depreciation deductions have on business’s
accounting?
- Reduces reported earnings without being a drain on the business’s current cash flow.
- Reduces the business’s tax bill.
- Allows the business to reinvest in new equipment or in further developing the business.
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17. How is an item’s accelerated depreciation calculated?
- Sum of the digits method. Depreciation deduction is calculated each by creating a
fraction, in which the numerator (the number being divided into) equals the years of
useful life remaining and the denominator (the dividing number) equals the sum of all the
useful yeas of life.
- For example- A truck with 1 five year life, the denominator is 5+4+3+2+1=15. In the
first year the numerator is 5 (fraction is 5 divided by 15 or 1/3). In second year the
numerator is 4 (fraction is 4 divided by 15 or 4/15).
18. What is the difference between straight-line depreciation, declining balance
depreciation, 150 percent declining balance depreciation, and accelerated cost recovery?
- Sum of the digits: The depreciation deduction is calculated each year by creating a
fraction in which the numerator (number divided into) equals the number of years by
creating a fraction, in which the numerator equals the number of years of useful life
remaining and the denominator equals the sum of all the useful years of life added
together.
- Declining balance: A stable fraction or percentage is applied to the current book value of
the asset (historical cost minus previous depreciation deductions) rather than to original
cost less salvage value (salvage value is not considered when applying this method).
- 150% declining balance depreciation: entails the use of a 30% rate of a five year asset
(using the declining balance method described above).
- Accelerated cost recovery system (ACRS) permits accelerated depreciation by allowing
the adoption of useful live are significantly shorter that the useful lives usually adopted
for depreciation purposes.
19. What is depletion?
- Depletion of natural resources. Gradual exhaustion of natural resources (coal mine,
forest).
- Take the original purchases price and divide it by the estimated recoverable resources in
the field or ore body to determine the cost per unit.
- As each unit is captured and recovered, the cost is shown as ―less‖.
20. What is amortization?
- Amortization of intangible assets and deferred charges is similar to depletion.
- It is not a problem for traditional intangibles such as copyrights, patents, and trademarks.
- The problem is with Research and development and dry wells. Have to show a
connection with the product to market to be able to amortize them at a later date.
- For example, if the asset is only good for 20 years, take 1/20 each year.
21. What special problems does inflation pose for cost based accounting methods?
- Dollar is worth less in each subsequent year.
- Artificial profits occurs simply when assets are held during inflationary periods. Need to
distinguish from real profits.
- Real costs should be viewed from business over entire productive plant replacement
cycle.
22. What is included as inventory for accounting purposes?
- Inventory for accounting includes: (1) all finished goods awaiting sale; (2) all goods in
various stages of production beginning with (and including) raw materials; and (3) all
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goods on hand that are ultimately consumed in the production of goods (raw materials,
intermediate goods, finished goods).
23. Why is it important to value inventory for accounting purposes?
- Control of inventory cost is a major component in determining whether or not a business
is successful. Avoids shrinkage. Also pilferage and shortages need to be avoided
24. Describe the difference between the weighted average method, first in first out (FIFO)
and last in fist out (LIFO) method of inventory accounting.
- Specific identification: keep track of cost of individual item and assign the cost of an item
in closing inventory as value of that item.
- Weighted average method: assigns weighted average to each unit. Not used except in
simple situations because too complex.
- For example: 200 times 5 + 100 times 6 + 400 times 7 + 200 times 8 + 300 times 9
divided by 1200 (total number of units) = 8700/1200= 7.25 per unit.
- First in, first out method (FIFO): earliest items in inventory sold first. Advantage-follows
physical practice in many businesses. Easy to administer. Eliminate possible
manipulation of gross profit. Also, reflects closely the actual market value.
- Last in, first out method: last items sold first. Advantage is that inventory replacement
costs rise because of inflation. Also, value of inventory for tax purposes. Also, causes
reported earnings to reflect accurately the most current costs of goods sold.
- Remember, as cost of goods go up, your net income goes down for nay method.
25. What does an accumulated retained earnings statement tell about a companies asset or
liabilities?
- It does not tell you about them.
Flat currency has no intrinsic value.Capitalism and Freedom
Chapter 1: The relation between economic freedom and political freedom.
1. What are the characteristics of a free market economy?
- Buy and sell what you want.
- Political freedom has historically been synonymous with free markets, i.e., where there is
political freedom there has always been ―something comparable to free market to
organize the bulk of economic activity.
2. Why is economic freedom a prerequisite to achieving political freedom?
- Historically, those societies that were an exception to tyranny, servitude, and misery had
an essentially free market system; capitalism is not a sufficient condition for political
freedom (private enterprises existed in Nazi Germany).
3. Are there any drawbacks to an economic system based upon laissez faire principles?
- Yes.
4. In what ways does today’s current welfare state detract from our individual freedoms?
- It leads to collectivist economic planning and centralized allocation of individuals to
occupations.
(a) What policy recommendations can you suggest to stop the U.S. continued
transformation into a welfare state.
- Stop these government programs.
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5. Will continued encroachment by the central government lead the U.S. down the road to
serfdom?
- Apparently so, collectivist economic planning has indeed interfered with individual
freedom.
6. According to Friedman, what are the two ways of coordinating the economic activities of
millions?
- (1) central direction involving the use of coercion; the technique of the army and of the
modern totalitarian state and (2) voluntary cooperation of individuals; the technique of
the market place.
(a) Placing the U.S. on a spectrum with total economic freedom at one extreme and
complete governmental (central) control over the economy at the other, where does the U.S.
fit in?
- Closer to the central side.
(b) In your opinion, in what direction is the U.S. moving?
- Back and forth.
7. How does freedom of exchange protect citizens from coercive activities of others (i.e.
participants in the market economy)?
- Protected from coercion of seller because there are other sellers the buyer can deal with.
- Both participants benefit from an economic transaction provided that the transaction is
bilaterally voluntary and informed; since no exchange will take place unless both parties
benefit from it, cooperation is thereby achieved without coercion.
8. What role (in the market place and society in general) should the government have
according to Friedman?
- Government is essential both as a forum for determining the rules of the game and as an
umpire to interpret and enforce the rules decided upon.
- The basic requisite is the maintenance of law and order to prevent physical coercion of
one individual by another and to enforce contracts voluntarily entered into.
9. How does economic power act as a check to political power and influence?
- The market reduces greatly the range of issues that must be decided through political
means and thereby minimizes the extent to which government need participant directly in
the game.
- Also, the fundamental threat to freedom is power to coerce, be it in the hands of a
monarch, a dictator.
- The preservation of freedom requires the elimination of such concentration of power to
the fullest possible extent and the dispersal and distribution of whatever power cannot be
eliminated- a system of checks and balances.
- By removing the organization of economic activity from the control of political authority,
the market eliminates this source of coercive power. It enables economic strength to be a
check to political power rather than a reinforcement.
10. How does a free market economy help alleviate the problems of racism and
discrimination within the U.S.?
- The market makes it costly for people to ―blacklist‖ others; the commercial emphasis, the
fact that people who are running enterprises have an incentive to make as much money as
they can protects the freedom of the individual who is blacklisted by providing him with
an alternative form of employment, and giving people an incentive to employ him.
- Also, consumers do not know who made their product.
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Chapter 2 The role of government in a free society.
1. How does the free market promote “unanimity without conformity”?
- The free market is a system of effectively proportional representation (as opposed to
political conformity which requires a limited number of alternatives such as ―yes‖ and
―no‖).
- Proportional representation allows for separate groups to have their interest represented.
- The fact that the final outcome generally must be a law applicable to all groups, rather
than a separate legislative enactments for each party represented means that PR in its
political version, far from permitting unanimity without conformity, tends toward
ineffectiveness and fragmentation. It thereby operates to destroy any consensus on which
unanimity with conformity can rest.
2. In what ways do political channels strain social cohesion?
- Every extension of the range of issues for which explicit agreement is sought strains
further the delicate threads that hold society together.
- If it goes so far as to touch an issue on which people feel deeply yet differently, it may
disrupt the society.
- Fundamental differences in basic values can seldom be resolved at the ballot box;
ultimately they can only be decided, though not resolved, by conflict. The religious and
civil wars of history are a testament to this judgment.
(a)How does the market work to reduce strain on society?
- The widespread use of the market reduces the strain on the social fabric by rendering
conformity unnecessary with respect to any activities in encompasses.
- The wilder the ranger of activities covered by the market, the fewer are the issues on
which political decisions are required and hence on which it is necessary to achieve
agreement.
- In turn, the fewer the issues on which agreement is needed, the greater the likelihood of
getting agreement while maintaining a free society.
3. What are the basic roles of the government in society?
- The basic roles of government in a free society is to provide a means whereby we can
modify the rules, to mediate differences among us on the meaning of the rules, and to
enforce compliance with the rules on the part of those few who would otherwise not play
the game.
- Government is the rule maker and umpire.
4. What is the major problem of deciding what activities the government should be
responsible for?
- Presents problems for freedom to combine and freedom to compete.
- Hard to resolve conflicts among the freedoms of different individuals.
5. What does the organization of economic activity through voluntary exchange presume?
- It exists only when nearly equivalent alternatives exist.
- The organization of economic activity through voluntary exchange presumes that we
have provided, through government, for the maintenance of law and order to prevent
coercion of one individual by another, the enforcement of contracts entered into, the
definition of the meaning of property rights, the interpretation and enforcement of such
rights, and the provision of a monetary framework.
6. Explain the concept of neighborhood effects?
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- Impedes voluntary exchange because it’s hard to identify effects on 3rd parties.
- An example is the pollution of a stream. The man who pollutes the stream is in affect
forcing others to exchange good water for bad. These others might be willing to make
the exchange at a price. But it is not feasible for them, acting individually, to avoid the
exchange or to enforce appropriate compensation.
7. How do monopolies threaten the existence of a free market economy?
- Exchange is truly voluntary only when nearly equivalent alternatives exist.
- Monopoly implies the absence of alternatives and thereby inhibits effective freedom of
exchange.
(a) How does governmental regulations affect prices?
- Governmental regulations serves to detract from competition in industries (railroads, and
mail), thereby preserving monopolies and driving up prices.
8. According to Friedman, what are some bad programs the government has initiated over
the years?
- Agricultural subsidies, import and export tariffs, government control of output, rent
control, legal minimum wage rates, detailed regulations of industries, social security
programs, bogus licenses for the purpose of collecting a tax, public housing, national
parks, monopoly of the mail system, and toll roads.
- Others include medicare, Medicaid, licenses for occupations (real estate license).
Chapter 3 The control of money
1. Why do some argue that a free enterprise economy is inherently unstable?
- Because when left to itself, it will produce recurrent cycles of boom and bust.
2. How does governmental intervention produce economic growth?
- Larger governmental intervention is taken on under the guise of economic growth to
show non-democratic countries that a democracy is the fastest way to grow an economy,
but government measures actually constitute major impediments to economic growth.
3. What are the ways (policies) utilized by the government to spur economic growth?
- Monetary policies and fiscal policies.
(a) Describe the function of each of these policies.
- They are to govern those areas where dispersal of power (the goal of Friedman) is not
possible, being the money supply and expenditures that cannot be individualized
(defense, etc.).
4. What does Lenin mean when he states that destroying a nation’s money will eventually
destroy the society itself?
- It is exemplified in more pedestrian fashion by the extent to which control of money has,
from time immemorial, enabled sovereign to exact heavy taxes from the populace at
large, very often without the explicit agreement of the legislature when there has been
one.
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5. How might we limit the government’s control over the money supply while at the same
time allowing the government to retain enough power to effectively aid in building the
nation’s economy?
- Establish institutional arrangements that will enable government to exercise
responsibility for money, yet at the same time limit the power thereby given to
government and prevent this power from being used in ways that will tend to weaken
rather than strengthen a free society.
6. Briefly explain what a gold standard (commodity standard) is and how it works.
- A simple commodity standard is the use as money some physical commodity such as
gold or silver, which in theory requires no government intervention, sine its price is
driven strictly by the cost of production.
7. What are the pros and cons of the U.S. returning to the gold standard?
- If it were feasible, it would provide an effective guarantee against tinkering with the
currency and against irresponsible monetary action.
- Historically, such a system has never been possible and fiduciary elements have been
introduced, which leads to extensive intervention by the state (including overprinting).
8. Why is the gold standard not feasible?
- It is not feasible because it would involve a large cost in the form of resources used to
produce the monetary commodity.
- It is not feasible because the mythology and beliefs required to make it effective do not
exist.
9. What are the responsibilities of the federal reserve?
- It was given power to create money if a widespread demand should arise on the part of
the part of the public for currency instead of deposits, and was given the means to make
cash available to banks on the security of the bank’s assets.
- It also has the means of tightening the money supply when the demand becomes too high.
(a) What do they have control over?
- The money supply.
(b) How do they exert their control (i.e. setting the interest rate)?
- They set the discount rate at which banks can borrow and determine the amount of
money in circulation.
C) How much influence does the federal reserve have in today’s economy?
- Too much, because it is subject to the-day-to-day whims of political authorities.
(d) What is the discount rate and how does it affect the economy?
- The rate at which the Fed lends money to its lender banks, which in turn governs the rate
at which these banks lend to the public and thus effects the expenses of borrowing money
(which serves to either expand or reduce the amount of money in circulation).
10. Why did the economy become more unstable after the creation of the Federal Reserve
System?
- Because the money supply was subject to political whims instead of general rules (the
Fed acted poorly during the depression by trying to protect the gold standard and not
putting more money into circulation).
- A few men control what is going to happen in the economy.
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11. What is the best way to limit the power of the Federal Reserve?
- Deny the Fed the opportunity to decide monetary policy on a case-by-case basis and set a
general monetary policy which takes into account the cumulative consequences of the
policy as a whole.
- If a general rule is adopted for a group of cases as a bundle, the existence of that rule has
favorable effects on people’s attitudes and beliefs and expectations that would follow
even from discretionary adoption of precisely the same policy on a series of separate
occasions.
(a) What type of power should the Fed Reserve have?
- I would specify that the Reserve System shall see to it that the total stock of money so
defined rises month by month, and indeed, so far as possible, day by day, at an annual
rate of X percent, where X is a number between 3 and 5.
12. Who should have power over the money supply?
- Some, but far less than at the present.
- Not Congress.
- The goal is that the public needs to be able to exercise control over monetary policy
through its political authorities, while at the same time preventing monetary policy from
being subject to the day-to-day whim of political authorities.
- Not the president.
Chapter 5 Fiscal Policy
1. Explain the concept of priming the pump.
- Temporary expenditures that get the economy going and the government can step out of
the picture.
(a) Why has the concept failed?
- It has failed to eliminate unemployment.
- Also, because the government has never actually stepped out of the picture.
- First it was the need to run a perpetual deficit to solve ―secular stagnation‖ and allow
individuals to accumulate savings; more recently, the emphasis has been on government
expenditures neither to prime the pump nor to hold in check the specter of secular
stagnation but as a balance wheel.
(b) Under the “pump” theory, what should the government do during times of recession and
prosperity respectively?
- When private expenditures decline for any reason, it is said that governmental
expenditures should rise to keep total expenditures stable; conversely, when private
expenditures rise, government expenditures should decline.
2. How have political influences affected the U.S. prime the pump philosophy?
- The chief harm done by the balance the wheel theory is therefore not that it has failed to
offset recessions, which it has, and not that it has introduced an inflationary bias into
governmental policy, which it has done, but that it has continuously fostered an
expansion in the range of governmental activities at the federal level and prevented a
reduction in the burden of federal taxes.
3. How does Friedman believe the government can assist the economy?
- What we need is not a skillful monetary driver of the economic vehicle continuously
turning the steering wheel to adjust to the unexpected irregularities of the route, but some
means of keeping the monetary passenger who is the back seat as ballast from
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occasionally leaning over and giving the steering wheel a jerk that threatens to send the
car off the road.
(a) Should the government have a significant or minor role in fiscal policy?
- Minor, plan tax rates so as to provide sufficient revenues to cover planned expenditures
on the average of one year with another (without regard to year-to-year economic
stability).
4. Explain the Keynesian multiplier?
- If 1/3 of government money is saved by those to whom it is given and 2/3 is spent again,
there will eventually be 3 times the total income gained.
(a) Does it work?
- No, because it does not account for price increases, what the government spends the
money on, and where the government gets the money.
5. Briefly, explain the difference between Keynesian and Friedman economic policy?
- Keynesian involves spending to take advantage of the Keynesian multiplier, i.e.,
government spending leading to roughly 3 times increase for every dollar spent (with a
Keynesian multiplier of 3).
- Friedman says that Keynes does not take into account what the government spends the
money on how the government gets the money, which in the best case scenario might
reach the Keynesian multiplier but will more likely be less helpful or harmful to the
economy.
(a) In your opinion, who has the best plan for the U.S.?
- Friedman, get rid of the government.
6. What is Keynes’ liquid trap and how does it work?
- When people are so utterly indifferent to whether they hold bonds or money, so that
bonds to get $100 can be sold without having to offer the higher return to the buyer than
such bonds were yielding before- this causes a liquidity trap so people buy the bonds with
idle money.
Chapter Seven Capitalism and Discrimination
1. How does capitalism reduce discrimination?
- There is an economic incentive in a free market to separate economic efficiency form
other characteristics of the individual.
- A business man who expresses preferences in his business activity that is not related to
productive efficiency is at a disadvantage compared to other individuals who do not.
- Such an individual is in effect imposing higher costs on himself than are other individuals
who do not have such preferences. Hence, in a free market they tend to drive him out.
- People do not know who is making their goods.
2. How does the element of discrimination affect the success and productivity of a business?
- Those of us who regard color of skin or religion as irrelevant can buy some things
cheaper as a result.
(a) Should a business hire a person based solely on that individual’s potential productivity?
- The color of a man’s skin or religion of his parents is by itself no reason to treat him
differently; a man should be judged on who he is and what he does, not by other external
characteristics.
3. Why do minority groups believe capitalism is more oppressive than socialism?
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- Some argue that interference with the freedom of individuals to enter into contracts with
one another with respect to employment is justified because the individual who refuses to
hire certain people based on their race, when both are equally qualified in terms of
productivity, is harming others, namely, the particular color of religious group whose
employment opportunities is limited in the process.
4. In what way does equal employment legislation affect freedom?
- It uses coercive power to force people to act in accordance with majority principles.
(a) Should the state be able to dictate who a business hires?
- No.
(b) What are the legal implications associated with requiring a business to hire a certain
amount of minorities?
- It allows the will of the majority to be implemented on the minority.
c) How does state interference affect contract rights?
- It limits them by preventing voluntary cooperation.
5. How can governmental interference with the free market affect free speech?
- A free market in ideas can’t be maintained without a free market in goods and services.
(a) Can a free market survive without free speech?
- No, momentary majorities must not be allowed to suppress the ideas of the minorities in
speech or the market place.
6. Why does Friedman believe the ACLU is a den of contradictions?
- Because it favors both free speech and fair employment laws (whereas employment laws
limit freedom in the market place).
7. How are fair employment laws and right to work laws related?
- Right to work laws make it illegal to require membership in a union as a condition for
employment.
- Both interfere with the freedom of the employment contract, in the one case by
specifying that a particular color or religion cannot be made a condition of employment;
in the other, that membership in a union cannot be.
(a) Aren’t right to work laws protecting the little-guy who does not want to join a union?
- No, they are removing economic freedom from employers to pay their workers as they
see fit.
(b) Is Friedman advocating giving more power to unions?
- No, he feels that employers should be free to pay their employees as they see fit, but that
monopoly power (which is usually found in closed shops) should be eliminated
regardless of the particular forms and manifestations it takes.
8. Why does Friedman believe there is a conflict between school segregation and
integration?
- Since schooling is primarily government run, it must do one or the other.
(a) Is there loss of freedom if integration is made mandatory?
- Yes.
9. In what ways does Friedman pose to solve the segregation problem?
- The appropriate solution is to eliminate government operation of the schools and permit parents
to choose the kind of school they
want their kids to attend.
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(a) Is allowing the parent to choose where to send a child to school going to increase the
homogeneous nature of the school system?
- Not necessarily, both segregated and integrated schools will develop depending on the
area.
(b) Is the voucher system the answer?
- It gets closer to the ultimate goal of letting parents decide and getting the government out
of education.
c) Is this a case where the freedom must be sacrificed in order to destroy the evils of
discrimination?
- No, removal of government from education would in this special area permit cooperation
without conformity.
10. Has forced integration had any noticeable affect on the racial demographics of
America’s schools?
- Yes, there would be less integration in the South as well as the inner cities without it.
(a) Are inner city schools still predominantly attended by minority students?
- Probably so.
Chapter 8 Monopoly & the social responsibility of business & labor
1. How much power does an individual have in affecting prices in the market?
- No individual can by himself have more than a negligible influence on prices, though all
participants together determine price by the combined effect of their separate actions.
2. How much power does a monopoly have in affecting prices in the market?
- The monopolist id visible in the market place and has power.
3. Are there any essential monopolies?
- Yes, the mail service, national defense, etc.
4. What are the problems with monopolies?
- Monopoly raises two classes of problems for a free society: (1) it means a limitation on
voluntary exchange through a reduction in the alternatives available to individuals and (2)
the existence of monopoly raises the issue of the social responsibility.
5. What are the three important areas of monopoly?
- Monopoly in industry, labor, and governmentally produced monopoly.
(a) Explain the pros and cons of each type of monopoly.
- Industry: Provide services that would otherwise not be there, but can also lead to
unchecked pricing.
- Labor: Unions, gain higher wages for higher wage earners at the expense of lower wage
earners.
- Government produced: FCC. Fed. Reserve are overbearing examples while property are
desirable government sponsored monopolies.
6. Would Friedman advocate governmental intervention in order to check the power of the
monopoly?
- No, he would favor a private monopoly system with no governmental intervention.
(a) Would intervention affect our freedom?
- Yes, FCC,
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(b) In terms of private monopolies, would Friedman advocate punishing an individual who
was able to create a monopoly (because of good business sense)?
- This would destroy a free society.
7. How do unions act like monopolies?
- By setting the rates for which labor must be paid in a particular industry at a rate higher
than what the market would otherwise pay.
(a) What effect to large, monopoly-like, unions have on wages and employment?
- Even string unions have a limited effect on the wage structure.
(b) How do unions harm the economy in general?
- They force the labor prices above what the market would otherwise pay, thus making the
amount of employment available in that occupation less than it otherwise would be.
- The effect is an increased number of people seeking other jobs, which forces down wages
in other occupations- i.e., since unions exist in otherwise high paying areas, their effect is
to make high paid workers higher paid at the expense of lower paid workers.
c) Why are unions able to act like cartels?
- Because of their exemption from the Sherman Act, unions can engage in striking to
reduce productivity and drive prices up, which keeps employers paying more to existing
workers at the expense of hiring new workers.
8. What are the three sources of monopolies?
- Technical considerations, direct and indirect governmental assistance, and private
collusion.
9. How do tariffs foster monopolies?
- By imposing handicaps on potential competitors (it is easier for a few firms than for
many to collude to fix prices).
(a) What effect do tariffs have on the domestic and international economies?
- Leads to monopolies domestically and less product sales by international firms.
(b) What is comparative advantage?
- The advantage domestic firms have over foreign firms where a tariff is involved.
10. Explain why corporate tax structure is in need of repair.
- The tax structure encourages internal retention of capital, rather than paying it to
shareholders as dividends, because this avoids double taxation- this leads to a waste of
capital, to its use for less productive rather than more productive purposes.
11. What action should the government take to curb the growth and power of monopolies?
- First, eliminate those measures which directly support monopoly, whether enterprise
monopoly or labor monopoly, and an even handed enforcement of the laws on enterprises
and labor unions alike; both should be treated alike with respect to laws bout the
destruction of property and about interference with private activities.
- Also reform the tax laws.
(a) What are anti-trust laws?
- Laws to prohibit private collusion.
(b) How does eliminating the corporate tax effect monopolies?
- Corporation would still be free to invest as much money as they wanted internally, but
they would have no incentive to do so except the proper incentive could earn more
internally.
- Few measures would do more to invigorate capital markets, to stimulate enterprises, and
to promote effective competition.
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c) Why should the government reduce the income tax rates?
- So long as the individual income tax rate is as highly graduated as it is now, there is
strong pressure to find devices to evade its impact.
- In this way as well as directly, the highly graduated tax constitutes a serious impediment
to the efficient use of our resources.
- The appropriate solution s the drastic scaling down of the higher rates, combined with an
elimination of the avoidance devices that have been incorporated in the law.
12. Do business people have a social responsibility to the community?
- The only responsibility of business is to use it resources and engage in activities designed
to increase its profits so long as it stays within the rules of the game, which is to say,
engage in open free competition, without deception or fraud.
(a) Is making profits the only responsibility a corporation/business should have?
- Few trends could so thoroughly undermine the foundation of our free society as the
acceptance by corporate officials of a social responsibility other than to make as much
money as possible for their stockholders.
(b) Does and should society expect something more from big business than to simply make
profits?
- No, imposing social responsibility only leads to such things as a concentration of
government power; or in the case of artificially low prices among competitors to keep the
interest rates down only leads to product shortages, labor shortages, and black markets.
c) Are there any economic advantages (i.e., goodwill) associated with doing good deeds for
the community?
- Friedman says that the corporation is an instrument of the stockholders who own it. If
the corporation makes a contribution, it prevents the individual stockholder from himself
deciding how he should dispose of his funds.
- Allowing corporate deductions for charitable giving drive a wedge between corporate
ownership and corporate control, which undermines the basic nature and character of our
society.
13. How do price controls affect the economy?
- Price controls, whether legal or voluntary, if effectively enforced would eventually lead
to the destruction of the free enterprise system and its replacement by a centrally
controlled system.
- It would not even be effective in preventing inflation.
- History offers ample evidence that what determines the average level of prices and wages
is the amount of money in the economy and not the greediness of businessmen or of
workers.
(a) Are there ever instances when price controls are needed?
- Probably not, since price controls are ineffectual anyway.
Chapter 10 The distribution of income
1. In your opinion, what is meant by the quote “to each according to what he and the
instruments he owns produces?”
- This is the ethical principle that would directly justify the distribution of income in a free
market society, i.e., it means equality strictly by money, rather than taking into account
other factors like leisure time, and dirty jobs.
2. How are the rules of property law intertwined with distribution of income principles?
- It depends on state actions.
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- The final distribution of income and wealth under the full operation of this principle may
well depend on the rules of property adopted by a state.
3. Why is society more apt to accept wealth acquired by chance as opposes to wealth
acquired by merit?
- Because the goddess of chance, as justice is blind, but merit based awards are a deliberate
judgment of relative merit (people get jealous when a co-worker gets a raise that they do
not, but not when the co-worker wins the lottery).
4. What is meant by the quote “the central principle of a market economy is cooperation
through voluntary exchange?
- Individuals cooperate with each other because they can satisfy their own needs more
effectively.
(a) Explain the connection between the above principle and the phrase “payment in
accordance with product.”
- Unless an individual receives the whole of what he adds to the product, he will enter into
exchanges on the basis of what he can receive rather than what he can produce.
- Exchanges will not take place that would have been mutually beneficial if each party
received what he contributed to the aggregate product.
- Payment in accordance with product is therefore necessary in order that resources be used
most effectively.
5. What is the great achievement of capitalism?
- It has been the accumulation of property, it has been the opportunities it has offered to
people to extend and develop and improve their capacities- i.e., in developed capitalistic
countries most of the income comes from human services and not capital (land), as in
underdeveloped countries.
(a) In your opinion, what are the negative ramifications of capitalism?
6. Why in a capitalist county is more income spent on human resources than on capital
resources?
- Because individuals are allowed to cooperate on a large scale; there is more ability to
earn income than simply through owning property.
(a) Is the U.S. economy more along the lines of a service oriented economy?
7. How has capitalism in conjunction with technology equalized the distribution of income?
- The advances in technology have made available to he masses of people luxuries that
were always available in one form or another to the truly wealthy.
(a) Why is technology more available in capitalist nations?
- Probably because everyone is able to cooperate in order to satisfy their wants, which
makes it profitable to develop these technologies for a greater number of people who can
afford them.
(b) Why are technological advances made more rapidly in capitalist nations (as opposed to
socialist nations)?
- More incentive to create the stuff (a bigger market for it).
8. How are distributions of income supposed to be equalized under the U.S. current tax
structure?
- Through graduated income brackets and inheritance taxation.
(a) Do wealthy people who hire better accountants get more breaks than the blue-collar
worker who simply cannot afford an accountant?
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- People at the same economic level pay different taxes depending of the accident of the
source of their income and the opportunities they have to invade them.
(b) Why is the graduated tax system a form of a governmental coercion?
- Graduated taxation solely to redistribute income seems a clear case of using coercion to
take from some in order to give it to others and thus conflict head-on with individual
freedom.
c) In reality, does the graduated tax system produce an equalization of income?
- NO, the personal income tax has been arbitrary in its impact and of limited effectiveness
in reducing inequality.
9. Why does Friedman believe a flat tax is the most appropriate method of taxation?
- A proportional flat tax would involve higher absolute payments by persons with higher
incomes for governmental services, which is not clearly inappropriate on grounds of
benefits conferred.
- Yet, it would avoid a situation where any large numbers could vote to impose on others
taxes that did not also affect their own tax burden.
(a) Do you believe a flat tax is the correct method of taxation?
- Yes.
(b) How will a flat tax conserve resources (in terms of policing through federal agencies
such as the IRS)?
- Probably eliminating the complicated loopholes that have to be checked- the only
investigation necessary would be if all income had been reported.
10. How does Friedman propose to reduce the inequitable distribution of income?
- Much of the inequality derives from the market.
- May of them have been create by government action or could be removed by government
action.
- The rules of the game could be adjusted so as to eliminate the sources of inequality.
- For example, special monopoly privileges granted by the government, tariffs, and other
legal enactments benefiting particular groups, are a source of inequality.
(a) What are some other ways to equalize incomes without a great deal of governmental
intervention?
- The extension and widening of educational opportunities has been a major factor tending
to reduce inequalities.
Chapter 11 Social welfare policies
1. Why should public housing be eliminated?
- Because the way to discourage the neighborhood effect (i.e., police and fire protection
cost more than subsidizing better neighborhoods) is to tax neighborhoods directly that
require greater services- cash should be given directly instead of housing because the
cash can always be used for housing (people are never worse off with cash).
- Thus, it cannot be justified on the grounds of either the neighborhood effect or of helping
poor families.
(a) Are there any benefits for continuing to subsidize public housing?
- It can be justified, if at all, only of the ground of paternalism; that the families being
helped need housing more than they need other things but would themselves either not
agree or would spend the money unwisely.
(b) Does Friedman’s approach seem harsh?
- Only to modern liberals.
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2. Why has public housing failed to improve the living standards of the poor?
- Because more houses are torn down in building public housing than new ones have been
built.
- The program is dominated by special interest that it could serve- in this case it was the
local groups that were anxious to have blighted areas cleared and refurbished, either
because they owned the property or because the blight was threatening local or central
business district.
- Also, these areas are concentrated with people that have problems.
- Cash subsidies would have spread these families thinner throughout the community.
3. Why have minimum wage laws had the opposite effect of what their creators had
planned?
- The intent was to reduce poverty by outlawing wage rates below specified levels.
- It can hardly require employers to hire at that minimum all those who were formerly
employed at wages below the minimum.
- The effect of the minimum wage is therefore to make unemployment higher than it
otherwise would be.
4. Explain why the consumer pays twice for subsidized food?
- The consumer has paid twice, once in taxes for farm benefit, and again by paying a
higher price for food.
5. How do tariffs (import quotas) affect international prices of food?
- A high price for cotton encouraged other countries to enlarge their cotton production.
- When our high price led to an unwieldy stock of cotton, we proceeded to sell overseas at
low prices and imposed heavy losses on the producers.
(a) How does the U.S. hurt other nations when it imposes import tariffs?
- See above answer.
6. Is there any justification for taxing the young in order to support the old?
- No, this redistribution cannot be defended.
- The subsidy to the beneficiaries is independent of their poverty or wealth- the tax that
pays the subsidy constitutes a larger fraction of low incomes than of high.
7. Should people be allowed to spend or invest their money as they please?
- Yes.
(a) Should the government take on a paternal role and force people to save for their old
age?
- No (see next question).
8. If people choose to squander their money-saving nothing for retirement-who should
support them in their later years?
- Those who believe in freedom must believe in the freedom of individuals to make their
own mistakes.
- If a man knowingly prefers to live for today, to use his resources for current enjoyment,
what right do we have to prevent his from doing this. We are not entitled to use coercion,
this goes against a free society.
(a) Is it better to force a person to save (either in a public or private annuities program)?
- See previous.
(b) How much should we value the freedom to make mistakes?
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- See previous. We could be the ones that are wrong.
9. Is there a danger of overwhelming agency power when all the experts in the agency’s
discipline work for that particular agency?
- They become self-governing bodies whose proposals are in the main rubber-stamped by
congress.
(a) Put another way; how are checks and balances supposed to operate properly when there
is no one (outside the agency) capable of understanding the internal operations of the
agency?
- The able and ambitious people who make their careers in them are naturally anxious to
expand the scope of their agencies and it is exceedingly difficult to prevent them from
doing so.
10 Should annuity plans be left entirely in the hands of the private sector?
- Yes, unless it is a fact that most people will become government charges (as during the
time the program was enacted, when 1/7 of the population was unemployed), since most
people will not become government charges.
(a) Should the government exert any control over annuities, and if so what types of
authority is appropriate?
- Again, paternalism is the only benefit of instituting the program; but the cost of
naturalization seem to outweigh any advantages.
- Friedman says that the program would work better if it was done like car insurance (you
must have it, but the government does not sell it), and for those that say the government
would offer a annuity, thus it should offer it on the open market against private plans,
which would lead to competition.
Chapter 12 The alleviation of poverty
1. Should assistance to the poor be handled through private of public organizations?
- Private is the most desirable- One of the major cost of the extension of governmental
welfare activities has been the corresponding decline in private charitable activities, i.e.,
the more we tend towards laissez faire the more private giving increases.
(a) Are there advantages to public control over private control (or vice versa)?
- For public control, people might be willing to contribute to the relief of poverty provided
that everyone else was as well.
2. How much assistance should be given to a poor individual?
- There is no way of deciding how much except in terms of the amount of taxes we are
willing to impose on ourselves for the purpose.
(a) How do we determine what amount of income is sufficient to raise a person to the
poverty level?
- The precise floor set would depend on what the community can afford.
3. Should people be given assistance because of their occupation/affiliation or should
assistance be determined solely from income levels?
- The program should be designed to help people as people not as members of a particular
occupational group or labor organization, this is a defect of farm programs, general old
age benefits, minimum wage laws, pro-union legislation, tariffs, licensing provisions.
4. How should assistance be allotted to prevent interference with the free market?
- While operating through the market, it should not distort the market or impede its
functioning. This is a defect of price supports, minimum wage laws and tariffs.
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5. Explain how tax subsidies/credits are a better alternative than our current welfare
system.
- They are directed at the problem of poverty, and it gives help in the form most useful to
the individual, namely, cash.
- It makes explicit the cost borne by society.
- It operates outside the market.
- Like any other measures to alleviate poverty, it reduces the incentive of those helped to
help themselves.
- An extra dollar earned always means more money available for expenditure.
6. Explain how the differences between equality of rights and equality of opportunity.
- Equality of rights is that each man be afforded the opportunity to make the most of his
capacities as long as he does not interfere with the rights of others to do the same;
equality of opportunity people have equal opportunity because if their equality of rights,
but hey choose to do different things with their freedoms and thus some will contribute
more to the general culture of society than others.
(a) Why do egalitarians go too far in trying to promote equality?
- They will defend taking from some to give to others, not as more effective means
whereby the some can achieve an objective they want to achieve.
- One cannot be both an egalitarian and a liberal. Must choose between the two.
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