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Collection of tutorials and a guide for using TGJU & Financial Markets
The impact that inflation has on the time value of money is it decreases the value of a dollar over time. The time value of money is a concept that describes how the money available to you today is worth more than the same amount of money at a future date. This also assumes you do not invest the money available to you today in an equity security, a debt instrument or an interest-bearing bank account. Essentially, if you have a dollar in your pocket today, that dollar will be worth less one year from today if you keep it in your pocket.
Inflation increases the prices of goods and services over time, effectively decreasing the amount of goods and services you can buy with a dollar in the future as opposed to a dollar today. If wages remain the same but inflation causes the prices of goods and services to increase over time, it will take a larger percentage of your income to purchase the same good or service in the future.
So, for example, if an apple costs $1 today, it’s possible that it could cost $2 for the same apple one year from today. This effectively decreases the time value of money, since it will cost twice as much to purchase the same product in the future. To mitigate this decrease in the time value of money, you can invest the money available to you today at a rate equal or higher than the rate of inflation. (For related reading, see: How to Profit From Inflation.)
A command economy is an economic system in which the government, or the central planner, determines what goods and services should be produced, the supply that should be produced, and the price of goods and services. Some examples of countries that have command economies are Cuba, North Korea and the former Soviet Union.
In a command economy, the government controls major aspects of economic production. The government decides the means of production and owns the industries that produce goods and services for the public. The government prices and produces goods and services that it thinks benefits the people.
A country that has a command economy focuses on macroeconomic objectives and political considerations to determine what goods and services the country produces and how much it will produce. It generally has macroeconomic goals that the government wants to meet, and it will produce goods and services to do so. The government allocates its resources based on these objectives and considerations.
For example, suppose a communist country with a command economic system has macroeconomic objectives of producing military items to protect its citizens. The country is in fear that it will go to war with another country within a year. The government decides it must produce more guns, tanks and missiles and train its military. In this case, the government will produce more military items and allocate much of its resources to do this. It will decrease the production and supply of goods and services that it feels the general public does not need. However, the population will continue to have access to basic necessities. In this country, the government feels military goods and services are socially efficient.
Historically, command economies don’t have the luxury of surplus production; chronic shortages are the norm. Since the days of Adam Smith, economists and public figures have debated the problem of overproduction (and underconsumption, its corollary). These issues were largely resolved by 19th century economist Jean-Baptiste Say, who demonstrated that general overproduction is impossible when a price mechanism exists.
To see the principle of Say’s law clearly, imagine an economy with the following goods: coconuts, jumpsuits and fish. Suddenly, the supply of fish triples. This does not mean that the economy will be overwhelmed with goods, workers will become desperately poor or that production will cease to be profitable. Instead, the purchasing power of fish (relative to jumpsuits and coconuts) will drop. The price of fish falls; some labor resources may be freed up and shift to jumpsuit and coconut production. The overall standard of living will rise, even if the allocation of labor resources looks different.
Command economies also have not had to deal with unemployment, because labor participation is compelled by the state; workers do not have the option of not working. It’s possible to eradicate unemployment by handing everyone a shovel and instructing them (under threat of imprisonment) to dig holes. It’s clear that unemployment (per se) is not the problem; labor needs to be productive, which necessitates that it can freely move to where it is most useful.
Command economies took most of the blame for the economic collapse of the Soviet Union and current conditions in North Korea. The lesson taken from…
If the Federal Reserve decides to lower the reserve ratio through an expansionary monetary policy, commercial banks are required to hold less cash on hand and are able to increase the amount of loans to give consumers and businesses. This increases the money supply, economic growth and the rate of inflation.
The Federal Reserve’s monetary policy is one of the ways in which the U.S. government tries to regulate the economy by controlling the money supply. It needs to balance economic growth with increasing inflation. If it adopts an expansionary monetary policy it expands economic growth but also increases the rate of inflation. If it adopts a contractionary monetary policy, it reduces inflation but also reduces growth.
The three ways in which the Federal Reserve achieves an expansionary or contractionary monetary policy is through the use of the discount rate; the reserve ratio or reserve requirements; and open market operations.
The reserve ratio dictates the reserve amounts required to be held in cash by banks. These banks can either keep the cash on hand in a vault or leave it with a local Federal Reserve bank. The exact reserve ratio depends on the size of a bank’s assets.
When the Federal Reserve lowers the reserve ratio, it lowers the amount of cash banks are required to hold in reserves and allows them to make more loans to consumers and businesses. This increases the money supply and expands the economy but also works to increase inflation.
Positive correlation between inflation and unemployment creates a unique set of challenges for fiscal policymakers. Policies that are effective at boosting economic output and bringing down unemployment tend to exacerbate inflation, while policies that rein in inflation frequently constrain the economy and worsen unemployment.
Historically, inflation and unemployment have maintained an inverse relationship, as represented by the Phillips curve. Low levels of unemployment correspond with higher inflation, while high unemployment corresponds with lower inflation and even deflation. From a logical standpoint, this relationship makes sense. When unemployment is low, more consumers have discretionary income to purchase goods. Demand for goods rises, and when demand rises, prices follow. During periods of high unemployment, customers demand fewer goods, which puts downward pressure on prices and reduces inflation.
In the United States, the most famous period during which inflation and unemployment were positively correlated was the 1970s. Termed stagflation, the combination of high inflation, high unemployment and sluggish economic growth that plagued this decade came about for several reasons. President Richard Nixon removed the U.S. dollar from the gold standard. Instead of being tied to a commodity with intrinsic value, the currency was left to float, its value subject to market whims.
Nixon implemented wage and price controls, which mandated the prices businesses could charge customers. Even though production costs increased under a shrinking dollar, businesses could not raise prices to bring revenues in line with costs. Instead, they were forced to cut costs by slashing payrolls to remain profitable. The value of the dollar shrank while jobs were being lost, resulting in positive correlation between inflation and unemployment.
No easy fix existed for solving the stagflation of the 1970s. Ultimately, Federal Reserve chairman Paul Volcker determined that long-term gain justified short-term pain. He took drastic measures to reduce inflation, raising interest rates as high as 20%, knowing these measures would result in temporary but sharp economic contraction. As expected, the economy entered a deep recession during the early 1980s with millions of jobs lost and gross domestic product (GDP) contracting by over 6%. The recovery, however, featured a robust rebound in gross domestic product, all of the lost jobs regained and then some, and none of the runaway inflation that characterized the preceding decade.
Positive correlation between inflation and unemployment can also be a good thing – as long as both levels are low. The late 1990s featured a combination of unemployment below 5% and inflation below 2.5%. An economic bubble in the tech industry was largely responsible for the low unemployment rate, while cheap gas amid tepid global demand helped keep inflation low. In 2000, the tech bubble burst, resulting in an unemployment spike, and gas prices began to climb. From 2000 to 2015, the relationship between inflation and unemployment once again followed the Phillips curve.
Generally speaking, inflation occurs if M2 money supply expands faster than the rate of productive growth in the overall economy. This means prices are higher than they otherwise would have been. It’s important to distinguish between certain components of M2, however. Cash and checking account balances affect inflation. Imperfectly liquid claims to money, such as money market mutual funds and traveler’s checks, are less significant to the relationship.
The Federal Reserve lists the following components in its M2 money supply: currency, nonbank travelers checks, demand deposit account balances, other checkable deposits, savings deposits and money market deposits at commercial banks or thrifts, small-time deposits, and retail money funds. The Fed and many economists consider these items to be money and money substitutes.
Legal tender currency, such as the U.S. dollar, has two defining characteristics: universal trade-ability for other goods and services, and its status as final payment for goods and services in the market.
Money directly chases all goods and services. Many money substitutes end up chasing money; their end goal is to be traded for dollars. For a money substitute to have a direct inflationary impact, it must ultimately be perfectly secure and immediately convertible at par value for standard currency.
This means that demand deposits and other checkable deposits can have direct inflationary impact. Other M2 substitutes fail one of the necessary criteria for direct money.
From an economic perspective, money is a unique good, but it is a good nonetheless. Its supply and demand determines its trade value in the market. Prices rise when the supply of money grows too quickly – faster than productivity – because a situation arises where relatively more money chases relatively fewer goods.
The relationship is not one for one, however. Money must be economically active to affect prices. This means money must be used in economic transactions in such a way that nominal income is changed. If the Fed prints up a trillion dollars that never circulate, inflation does not occur.
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After the bell” is financial slang for activity occurring after the close of the stock market, including after-hours trading, illegal late trading of open-ended funds (during the mutual fund scandal of 2003), earnings announcements, acquisition plans and merger agreements. The term originates from the ringing of the bell on the NYSE, which denotes the open and close of trading sessions.
Generally, important, company-specific news is released after the bell to give investors time to dig through the information and make informed buy and sell decisions. In addition, announcements after the close of trading provide order and stability to the markets. News released during the trading day or before the bell (prior to the start of the trading session) could generate negative consequences, like panic-selling, unbridled speculation and buy/sell imbalances. Pertinent news announced after the bell leads traders to trade stock based on the fresh information, although in very thin markets. However, it should be noted that traders may trade stock after the bell for a variety of reasons, which may not be related to company news releases. (For more on this topic, read What is after-hours trading?)
This question was answered by Justin Bynum.
In theory, the impact that disposable income has on the stock market is that a widespread increase in disposable income leads to increases in stock valuations and, therefore, increases the overall value of the stock market.
Disposable income is defined as the total amount of household income that’s available for spending and saving after paying income taxes.
If disposable income increases, households have more money to either save or spend, which naturally leads to a growth in consumption. This increase in consumption could increase corporate sales and corporate earnings, increasing the value of individual stocks. This increase in individual share price valuations could then lead to a market-wide increase in value. This potentially leads to an economic boom.
The opposite also holds true. If disposable income decreases, households have less money to spend and save, which then forces consumers to consume less and become more frugal. This decrease in consumption could then decrease corporate sales and corporate earnings, decreasing the value of individual stocks. This decrease in individual share price valuations could then lead to a market-wide decrease in value. This potentially leads to a depression or recession.
Increases in disposable income don’t always result in an increase in value of the stock market, and vice versa.
Sometimes, especially in the wake of a recession and during a recovery period, although disposable income increases, many consumers remain frugal and do not use the increases in disposable income to increase consumption. When this occurs, even an increase in disposable income can lead to a recession since, as of 2015, over 70% of U.S. GDP is accounted for by consumption.
In microeconomics, utility represents a way to relate the amount of goods consumed to the amount of happiness or satisfaction a consumer gets. Marginal utility tells how much marginal value or satisfaction a consumer gets from consuming an additional unit of good. Microeconomic theory states that consumer choice is made on margins, meaning consumers constantly compare marginal utility from consuming additional goods to the cost they have to incur to acquire such goods. A consumer buys goods as long as the marginal utility for each additional unit exceeds its price. A consumer stops consuming additional goods as soon as the price exceeds the marginal utility.
In microeconomics, marginal utility and the law of diminishing marginal utility are the fundamental blocks that provide insight into the consumer choice of quantity and type of goods to be consumed. The law of diminishing marginal utility states the marginal utility from an additional unit of consumption declines as the quantity of consumed goods increases. Consumers choose their baskets of goods by equating marginal utility of a good to its price, which is a marginal cost of consumption.
The price a consumer is willing to pay for a good depends on his marginal utility, which declines with each additional unit of consumption, according to the law of diminishing marginal utility. Therefore, the price decreases for a normal good when consumption increases. The price and quantity demanded are inversely related, which represents the fundamental law of demand in consumer choice theory.
Governments may make policy changes in response to economic conditions. Government regulation of the economy is frequently used to engineer economic growth or prevent negative economic consequences. During periods of weak growth, Keynesian economists recommend lowering interest rates to encourage borrowing and restore economic growth. In response to inflation concerns, governments may decide to increase interest rates. Government policies may use tax incentives to direct economic conditions also. The active use of these strategies demonstrates government interest in preserving particular economic circumstances to further the economic well-being of important stakeholders and the public.
In the United States, the Federal Reserve has the authority to direct economic policy for the country as a whole. Established in 1913, the Federal Reserve controls the money supply and actively uses policy to respond to and influence economic conditions. Increasing or decreasing available funds influences bank behavior. Banks are offered a discount rate by the Federal Reserve on funds borrowed to re-lend to consumers and industry clients. Changing the costs of borrowing by changing rates is another means of directing bank activity. Major banks have tremendous influence on the consumer economy because they are gatekeepers. Funds flow from the Federal Reserve to the major banks and the government actively uses this means to direct the economic rate of growth.
Outside events may influence economic activity and governments may use economic means to enact changes. Tax policy is frequently used to direct economic action, as is legislation. Government responses to economic conditions typically include using multiple strategies simultaneously.
The Dow Jones Industrial Average (DJIA) is the second-oldest and best-known stock market index. Owned by Dow Jones & Company, it measures the daily price movements of 30 large American companies on the Nasdaq and the New York Stock Exchange. It is widely viewed as a proxy for general market conditions and even the U.S. economy itself.
Started in 1896, the DJIA is comprised of blue-chip stocks, approximately two-thirds of which are represented by companies producing industrial and consumer goods. The rest are chosen from all the major sectors of the economy including information technology, entertainment and financial services.
The Dow Jones Industrial Average (DJIA), popularly referred to as “The Dow,” is regarded as the “pulse of the stock market,” as it is one of the most quoted and followed stock market indexes by investors, financial professionals and the media. The Dow was unveiled on May 26, 1896 by Charles H. Dow and Edward Jones as a composition of 12 industrial-company stocks. Dow, a financial journalist, believed that investors should have an impersonal, numbers-based benchmark to see how the stock market was trending. The published average of the first index was a roaring 40.94.
Today, the DJIA’s components are chosen from all the major sectors of the economy, with the exception of the transportation and utilities industries. Stocks from these sectors are covered by the Dow Jones Transportation Average (DJTA) (which was Dow and Jones’ first index, the oldest in the U.S.) and Dow Jones Utility Average (DJUA). The current roster includes the likes of Apple, Goldman Sachs, Microsoft, Coca-Cola, Exxon Mobil and General Electric (the only corporation that has been included since 1896).
The component stocks of the DJIA are not permanent; new additions and deletions are made from time to time based on certain non-quantitative criteria. Only companies with a substantial growth record and wide investor interest are considered for inclusion.
The DJIA was calculated by hand hourly for a number of years. Back in 1896, Charles Dow simply added up the prices of the 12 stocks and divided them by 12. In 1923, Arthur “Pop” Harris was assigned the task of calculating these numbers. After his retirement in 1963, computers were used to calculate the figures. Originally, there was a delay of about seven minutes between the close of the NYSE until the final number came out over the wires. Eventually, electronic technology enabled a constant minute-by-minute calculation of the average while the market is trading.
The DJIA is a price-weighted index, which means stocks with higher share prices are given a greater weight in the index. Instead of dividing by the number of stocks in the average, as is done in an arithmetic average, the sum of the component stock prices is divided by a special divisor. The purpose of this Dow divisor, which is continually adjusted, is to smooth out the effects of stock splits, dividends paid or corporate spinoffs; this allows for a consistent index, keeping the Dow from getting distorted by one-time events. The result is the DJIA is affected only by changes in the stock prices, and stocks with a higher share price have a larger impact on the Dow’s movements.
The DJIA is simply a reflection of the weighted average of the stock prices and can be considered a price in itself. If the quote …