Economics Week: Part-1

Introduction
Sometimes, when you want to learn about everything around you, you find yourself nowhere when it comes to the point "From where to start?"..That is why I have decided to celebrate every week as a curriculum for learning some of the most basic and mind boggling things around me. In this way, I will be giving utmost attention to every aspect of the topic in detail. So here goes, the first of this series: Economics Week.
I celebrated (self-made) Economics Week from Feb-1-2010 to Feb-7-2010 to learn some basic economic terms and then went on to learn the economics of India and the World. As it will be quite cumbersome to present it in a single post, I have divided this into 2 parts.

Here's presenting the first part:

Basic Economic Terms

1. Macroeconomics and Microeconomics
Macroeconomics looks at the total output of a nation and the way the nation allocates its limited resources of land, labor and capital in an attempt to maximize production levels and promote trade and growth for future generations.
Macroeconomics is focused on the movement and trends in the economy as a whole, while in microeconomics the focus is placed on factors that affect the decisions made by firms and individuals. The factors that are studied by macro and micro will often influence each other, such as the current level of unemployment in the economy as a whole will affect the supply of workers which an oil company can hire from, for example.

Microeconomics looks into similar issues, but on the level of the individual people and firms within the economy. It is the branch of economics that analyzes the market behavior of individual consumers and firms in an attempt to understand the decision-making process of firms and households. It is concerned with the interaction between individual buyers and sellers and the factors that influence the choices made by buyers and sellers. In particular, microeconomics focuses on patterns of supply and demand and the determination of price and output in individual markets (e.g. coffee industry).

It tends to be more scientific in its approach, and studies the parts that make up the whole economy. Analyzing certain aspects of human behavior, microeconomics shows us how individuals and firms respond to changes in price and why they demand what they do at particular price levels.

2. CRR Rate in IndiaCash reserve Ratio (CRR) is the amount of funds that the banks have to keep with RBI. If RBI decides to increase the percent of this, the available amount with the banks comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks. The upper limit of CRR is 15% while there is no lower limit.

3. Repo rate in India
When the banks have any shortage of funds they can borrow it either from Reserve Bank of India [RBI] or from other banks. The rate at which the RBI lends money to commercial banks is called repo rate. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive. The repo rate in India is analogous to the discount rate in the US. It is an instrument of the monetary policy.

4. Central Excise duties
These duties are levied by the Central Government on commodities, which are produced within the country. But commodities on which State Governments impose excise duties (as for instance, on liquor and drugs) are exempted from Central Excise Duties.

5. IMF
The International Monetary Fund was conceived in July 1944 during the United Nations Monetary and Financial Conference. The representatives of 45 governments met in the Mount Washington Hotel in the area of Bretton Woods, New Hampshire, United States, with the delegates to the conference agreeing on a framework for international economic cooperation. The IMF was formally organized on December 27, 1945, when the first 29 countries signed its Articles of Agreement

6. Stock Market
A stock market is a public market for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. Actual trades are based on an auction market model where a potential buyer bids a specific price for a stock and a potential seller asks a specific price for the stock. When the bid and ask prices match, a sale takes place, on a first-come-first-served basis if there are multiple bidders or askers at a given price.

Importance of stock market:
The stock market is one of the most important sources for companies to raise money. Also, the stock market is often considered the primary indicator of a country's economic strength and development. Rising share prices, for instance, tend to be associated with increased business investment and vice versa. Share prices also affect the wealth of households and their consumption.

Factors affecting Stock Market:Market sentiment, the performance of the industry, The earning results and earning guidance, take-over or merger, New product introduction to markets or introduction of an existing product to new markets, Share buy-back, Dividend, etc

7. P/E ratio
The P/E ratio (price-to-earnings ratio) of a stock (also called its "P/E", "PER", "earnings multiple," or simply "multiple") is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio. The P/E ratio has units of years, which can be interpreted as "number of years of earnings to pay back purchase price", ignoring the time value of money. In other words, P/E ratio shows current investor demand for a company share.

Interpretation of P/E ratio:

N/A A company with no earnings has an undefined P/E ratio. By convention, companies with losses (negative earnings) are usually treated as having an undefined P/E ratio, although a negative P/E ratio can be mathematically determined.
0–10 Either the stock is undervalued or the company's earnings are thought to be in decline. Alternatively, current earnings may be substantially above historic trends or the company may have profited from selling assets.
10–17 For many companies a P/E ratio in this range may be considered fair value.
17–25 Either the stock is overvalued or the company's earnings have increased since the last earnings figure was published. The stock may also be a growth stock with earnings expected to increase substantially in future.
25+ A company whose shares have a very high P/E may have high expected future growth in earnings or the stock may be the subject of a speculative bubble.

8. PPP-Purchasing Power Parity
The exchange rate adjusts so that an identical good in two different countries has the same price when expressed in the same currency.

For example, a chocolate bar that sells for C$1.50 in a Canadian city should cost US$1.00 in a U.S. city when the exchange rate between Canada and the U.S. is 1.50 USD/CDN. (Both chocolate bars cost US$1.00.)

9. InflationIt is the rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum.

Measuring Inflation:
A number of goods that are representative of the economy are put together into what is referred to as a "market basket." The cost of this basket is then compared over time. This results in a price index, which is the cost of the market basket today as a percentage of the cost of that identical basket in the starting year.

10. WPI and CPI

CPI is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. The CPI is calculated by taking price changes for each item in the predetermined basket of goods and averaging them; the goods are weighted according to their importance.

Consumer Price Index (CPI) in India comprises multiple series classified based on different economic groups. There are four series, viz the CPI UNME (Urban Non-Manual Employee), CPI AL (Agricultural Labourer), CPI RL (Rural Labourer) and CPI IW (Industrial Worker). While the CPI UNME series is published by the Central Statistical Organisation, the others are published by the Department of Labour.

Wholesale Price Index (WPI) was first published in 1902, and was one of the more economic indicators available to policy makers until it was replaced by most developed countries by the Consumer Price Index in the 1970s. WPI is the index that is used to measure the change in the average price level of goods traded in wholesale market. In India, a total of 435 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions. It is also the price index which is available on a weekly basis with the shortest possible time lag only two weeks.

11. Fiscal Deficit

When a government's total expenditures exceed the revenue that it generates (excluding money from borrowings). Deficit differs from debt, which is an accumulation of yearly deficits.

12. GDP & GNP

GDP:

The monetary value of all the finished goods and services produced within a country's borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory.

GDP = C + G + I + NX

where:

"C" is equal to all private consumption, or consumer spending, in a nation's economy

"G" is the sum of government spending

"I" is the sum of all the country's businesses spending on capital

"NX" is the nation's total net exports, calculated as total exports minus total imports. (NX = Exports - Imports)

Importance of GDP:

GDP is commonly used as an indicator of the economic health of a country, as well as to gauge a country's standard of living. Critics of using GDP as an economic measure say the statistic does not take into account the underground economy - transactions that, for whatever reason, are not reported to the government. Others say that GDP is not intended to gauge material well-being, but serves as a measure of a nation's productivity, which is unrelated.

Nominal GDP:It is a gross domestic product (GDP) figure that has not been adjusted for inflation. It can be misleading when inflation is not accounted for in the GDP figure because the GDP will appear higher than it actually is. For example, if the nominal GDP figure has shot up 8% but inflation has been 4%, the real GDP has only increased 4%.

Real GDP:

This inflation-adjusted measure that reflects the value of all goods and services produced in a given year, expressed in base-year prices.

Nominal GDP Growth vs. Real GDP Growth*
GDP, or Gross Domestic Product is the value of all the goods and services produced in a country. The Nominal Gross Domestic Product measures the value of all the goods and services produced expressed in current prices. On the other hand, Real Gross Domestic Product measures the value of all the goods and services produced expressed in the prices of some base year. An example:


Suppose in the year 2000, the economy of a country produced $100 billion worth of goods and services based on year 2000 prices. Since we're using 2000 as a basis year, the nominal and real GDP are the same. In the year 2001, the economy produced $110B worth of goods and services based on year 2001 prices. Those same goods and services are instead valued at $105B if year 2000 prices are used. Then:
Year 2000 Nominal GDP = $100B, Real GDP = $100B
Year 2001 Nominal GDP = $110B, Real GDP = $105B
Nominal GDP Growth Rate = 10%
Real GDP Growth Rate = 5%

GNP:

Gross National Product is the total value of all final goods and services produced within a nation in a particular year, plus income earned by its citizens (including income of those located abroad), minus income of non-residents located in that country. Basically, GNP measures the value of goods and services that the country's citizens produced regardless of their location. GNP is one measure of the economic condition of a country, under the assumption that a higher GNP leads to a higher quality of living, all other things being equal.

13. FDI and FII

Foreign direct investment (FDI) is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic globalization.

Methods of FDI: By incorporating a wholly owned subsidiary or company, by acquiring shares in an associated enterprise, through a merger or an acquisition of an unrelated enterprise, participating in an equity joint venture with another investor or enterprise.

Foreign Institutional Investor (FII) is used to denote an investor - mostly of the form of an institution or entity, which invests money in the financial markets of a country different from the one where in the institution or entity was originally incorporated.

Why is FDI better than FII:

FDI is preferred over FII investments since it is considered to be the most beneficial form of foreign investment for the economy as a whole. Direct investment targets a specific enterprise, with the aim of increasing its capacity/productivity or changing its management control. Direct investment to create or augment capacity ensures that the capital inflow translates into additional production. In the case of FII investment that flows into the secondary market, the effect is to increase capital availability in general, rather than availability of capital to a particular enterprise. Translating an FII inflow into additional production depends on production decisions by someone other than the foreign investor — some local investor has to draw upon the additional capital made available via FII inflows to augment production. In the case of FDI that flows in for the purpose of acquiring an existing asset, no addition to production capacity takes place as a direct result of the FDI inflow. Just like in the case of FII inflows, in this case too, addition to production capacity does not result from the action of the foreign investor – the domestic seller has to invest the proceeds of the sale in a manner that augments capacity or productivity for the foreign capital inflow to boost domestic production. There is a widespread notion that FII inflows are hot money — that it comes and goes, creating volatility in the stock market and exchange rates. While this might be true of individual funds, cumulatively, FII inflows have only provided net inflows of capital.

FDI tends to be much more stable than FII inflows. Moreover, FDI brings not just capital but also better management and governance practices and, often, technology transfer. The know-how thus transferred along with FDI is often more crucial than the capital per se. No such benefit accrues in the case of FII inflows, although the search by FIIs for credible investment options has tended to improve accounting and governance practices among listed Indian companies.

14. Subsidies

The Oxford English Dictionary defines subsidy as “money granted by State, public body etc to keep down the prices of commodities etc”

Objectives of Subsidies

Subsidies, by means of creating a wedge between consumer prices and producer costs, lead to changes in demand/ supply decisions. Subsidies have a tendency to self-perpetuate. They create vested interests and acquire political hues.

Subsidies are often aimed at :

• inducing higher consumption/ production

• offsetting market imperfections including internalization of externalities;

• achievement of social policy objectives including redistribution of income, population control, etc.

15. Oligopoly*
A situation in which a particular market is controlled by a small group of firms. It is a market situation in which producers are so few that the actions of each of them have an impact on price and on competitors.
An oligopoly is much like a monopoly, in which only one company exerts control over most of a market. In an oligopoly, there are at least two firms controlling the market. Because each firm in an oligopoly knows its share of the total market for the product or service it produces, and because any change in price or change in market share by one firm is reflected in the sales of the others, there tends to be a high degree of interdependence among firms; each firm must make its price and output decisions with regard to the responses of the other firms in the oligopoly, so that oligopoly prices, once established, are rigid. This encourages nonprice competition, through advertising, packaging, and service-a generally nonproductive form of resource allocation.

16. Cartel*
A small group of producers of a good or service who agree to regulate supply in an effort to control or manipulate prices. The best known example of a cartel is probably the Organization of Petroleum Exporting Countries (OPEC).

*Added later on NjoyTV

This is the end of Part-1.