Chapter 1 Financial and Economic Concepts
CHAPTER OUTLINE
Learning Objectives
Basic Financial Concepts
Importance of Finance
Economic Concepts of Finance
Scarce Resources
Opportunity Costs
Savings, Income, Expenditures, and Taxes
Factors Affecting Interest Rates
Supply of Money Saved
REVIEW AND DISCUSSION QUESTIONS
2. What is a market? A market consists of any organized effort where buyers and sellers freely
exchange goods and services.
a) Name five types of markets in which you participate: Financial, real estate, retail,
wholesale, commodities, stock markets, bond markets, money markets, and flea. Students
basically can discuss any market that makes sense to them.
3. Compare marginal revenue, marginal cost, and marginal revenue product. Marginal revenue
4. Distinguish between economic and financial capital. Economic capital resources include all items
5. Discuss the value of the entrepreneur. What distinguishes the entrepreneur from the labor
resource? Why are entrepreneurs unique? Entrepreneurial resources consist of the ideas of
6. What is opportunity cost? An opportunity cost is the highest value that is surrendered when a
7. What makes up gross income? All of the money received from all sources during the year. This
8. Compare progressive, regressive, and proportional taxes. Give at least one example of each
type of tax. Progressive taxes are taxes that take a larger percentage of your income as your income
9. What is the law of supply? The law of supply states that as the payment or price of an item
increases, ceteris paribus, we will supply more of that item.
10. What is a supply table? How do you obtain a supply curve from a supply table? A supply
11. What is the law of demand? The Law of Demand states that if all other factors are constant, as the
price for an item decreases, people will demand more of that item, ceteris paribus.
12. Explain the concept of a surplus of money versus a shortage of money. When the supply of
13. What is the Federal Reserve? What are the Fed’s three tools for controlling the money
supply? The Federal Reserve is the Central Bank of the United States. The three tools for
controlling the money supply are the discount rate, the reserve requirements ratio, and federal open
market operations.
14. What is risk? What is the difference between systematic and unsystematic risk? Risk involves
EXERCISES AND PROBLEMS
1. Carry Yoki’s Lounge consists of the following. Carry, the owner believed that people would come to hear
a band play on Friday, Saturday, and Sunday evening. During the remainder of the week, she believed
her customers would watch sporting events on several television sets located throughout the lounge.
Carry employed two bartenders, three servers, two assistant servers, two cooks, one dishwasher and a
clean-up person. She had a bar, 15 barstools, 4 tables, 40 chairs, 4 television sets, and one satellite dish.
She had an oven, stove, grill, refrigerator, sinks, dishes, and glassware. Carry started this business with
$50,000 of her own money, and she borrowed $150,000 from the bank. From this description, list each of
the scarce resources that are used in Carry Yoki’s Lounge.
Entrepreneurial resource: Carry Yoki.
2. Joe Fixit has an appliance repair business. He has more business than he can handle and wants to hire
another repair person. Joe estimates that three appliances can be repaired each hour by a qualified
person. Joe bills out labor at $45 per hour, but he stipulates that the minimum charge for appliance
repair estimates is $30 plus parts. What is the marginal revenue product of a qualified repair person?
What is the maximum hourly wage that he would pay an employee?
3. Sam Smith is currently employed as a mechanical engineer and is paid $65,000 per year plus benefits that
are equal to 30% of his salary. Sam wants to begin a consulting firm and decides to leave his current job.
After his first year in business, Sam’s accountant informed him that he had made $45,000 with his
consulting business. Sam also notices that he paid $6,000 for a health insurance policy, which was his
total benefit during his first year. What was Sam’s opportunity cost?
Sam gave up $65,000 in salary plus $19,500 in benefits or a total of $84,500.
4. Sara Lee just graduated from college with a degree in accounting. She had five job offers: Bean
Counters CPA, $35,000; Assets R Us, $27,000; The Debit Store, $30,000; J & J’s CPA’s, $33,000; and The
Double Entry Shop, $40,000. What was her opportunity cost if she accepted the job with The Double
Entry Shop?
5. Sam Club earned $50,000 and paid taxes of $10,000. Samantha Heart earned $60,000 and paid taxes of
$12,000. If these taxes were paid to the same government agency, is the tax on income progressive,
regressive, or proportional? Why did you reach this conclusion? As show below these taxes are
proportional because they both paid the same percentage of their income in taxes.
6. You read an article in this morning’s paper that stated inflation was accelerating and would reach
six percent this year. If the FED believes this statement and it has set a goal of three percent
inflation, what will it likely do at the next meeting of the Federal Open Market Committee? They
7. A friend came into your office and said that his bank was out to kill small businesses. You asked him
what he meant by this remark, and he said that he read an article that said his bank had just loaned
$10 million to a major automobile manufacturer at a rate of 3 percent, which is less than prime. But
your friend just borrowed $50,000 from the same bank and they charged him prime plus four
percent, or 7.5 percent. Your friend has been in business for two years, and last year he had a loss of
$2,000. How can you explain this difference in interest rate to your friend? The bank charges interest
based upon risk. The probability of the automobile manufacturer defaulting on the loan is very remote;
RECOMMENDED TEAM ASSIGNMENT
There are no solutions to the team assignments as they involve research and will vary based on the
economic circumstances at the time of the assignment:
1. Using online resources, describe what measures the Federal Reserve Bank
adopted in the past year to make adjustments in the U.S. economy in order to
reach the Fed’s goals.
CASE STUDY QUESTIONS
1. What effect did changes in government regulations have on the way Macy’s had to conduct its
business? When the Fair Trade laws were rescinded Macy’s had to compete on service because the
2. What effect did the economy and current interest rates have on the ability of Macy’s to sell their
business? During the 1980’s real estate values began to tumble, interest rates on savings reached 15% and