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Getting additional education and saving money early in life obviously will not make you rich overnight. Additional education typically means putting off earning income and living as a student for more years. Saving money often requires choices like driving an older or less expensive car, living in a smaller apartment or buying a smaller house, and making other day-to-day sacrifices. For most people, the tradeoffs for achieving substantial personal wealth will require effort, patience, and sacrifice.

How capital markets transform financial flows

Financial capital markets have the power to repackage money as it moves from those who supply financial capital to those who demand it. Banks accept checking account deposits and turn them into long-term loans to companies. Individual firms sell shares of stock and issue bonds to raise capital. Firms make and sell an astonishing array of goods and services, but an investor can receive a return on the company’s decisions by buying stock in that company. Stocks and bonds are sold and resold by financial investors to one another. Venture capitalists and angel investors search for promising small companies. Mutual funds combine the stocks and bonds—and thus, indirectly, the products and investments—of many different companies.

Visit this website to read an article about how austerity can work.

In this chapter, we discussed the basic mechanisms of financial markets. (A more advanced course in economics or finance will consider more sophisticated tools.) The fundamentals of those financial capital markets remain the same: Firms are trying to raise financial capital and households are looking for a desirable combination of rate of return, risk, and liquidity. Financial markets are society’s mechanisms for bringing together these forces of demand and supply.

The housing bubble and the financial crisis of 2007

The housing boom and bust in the United States, and the resulting multi-trillion-dollar decline in home equity, started with the fall of home prices starting in 2007. As home values fell, many home prices fell below the amount owed on the mortgage and owners stopped paying and defaulted on their loan. Banks found that their assets (loans) became worthless. Many financial institutions around the world had invested in mortgage-backed securities, or had purchased insurance on mortgage-backed securities. When housing prices collapsed, the value of those financial assets collapsed as well. The asset side of the banks’ balance sheets dropped, causing bank failures and bank runs. Around the globe, financial institutions were bankrupted or nearly so. The result was a large decrease in lending and borrowing, referred to as a freezing up of available credit. When credit dries up, the economy is on its knees. The crisis was not limited to the United States. Iceland, Ireland, the United Kingdom, Spain, Portugal, and Greece all had similar housing boom and bust cycles, and similar credit freezes.

If businesses cannot access financial capital, they cannot make physical capital investments. Those investments ultimately lead to job creation. So when credit dried up, businesses invested less, and they ultimately laid off millions of workers. This caused incomes to drop, which caused demand to drop. In turn businesses sold less, so they laid off more workers. Compounding these events, as economic conditions worsened, financial institutions were even less likely to make loans.

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, demand, consumption, and employment, and to the Great Recession, which in the United States officially lasted from December 2007 to June 2009. During this time, the unemployment rate rose from 5% to a peak of 10.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

As the world’s leading consumer, if the United States goes into recession, it usually drags other countries down with it. The Great Recession was no exception. With few exceptions, U.S. trading partners also entered into recessions of their own, of varying lengths, or suffered slower economic growth. Like the United States, many European countries also gave direct financial assistance, so-called bailouts, to the institutions that make up their financial markets. There was good reason to do this. Financial markets bridge the gap between demanders and suppliers of financial capital. These institutions and markets need to function in order for an economy to invest in new financial capital.

However, much of this bailout money was borrowed, and this borrowed money contributed to another crisis in Europe. Because of the impact on their budgets of the financial crisis and the resulting bailouts, many countries found themselves with unsustainably high deficits. They chose to undertake austerity measures, large decreases in government spending and large tax increases, in order to reduce their deficits. Greece, Ireland, Spain, and Portugal have all had to undertake relatively severe austerity measures. The ramifications of this crisis have spread; the viability of the euro has even been called into question.

Key concepts and summary

It is extremely difficult, even for financial professionals, to predict changes in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they follow two rules: complete significant additional education and training after graduating from high school and start saving money early in life.

Problems

How much money do you have to put into a bank account that pays 10% interest compounded annually to have $10,000 in ten years?

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Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $5,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns 4.75%. After 30 years, how much more will Alexx have than Spenser?

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References

U.S. Department of Commerce: United States Census Bureau. “Income: Table H-13. Educational Attainment of Householder—Households with Householder 25 Years Old and Over by Median and Mean Income.” http://www.census.gov/hhes/www/income/data/historical/household/.

United States Department of Labor. Bureau of Labor Statistics. 2015. “Table 9. Quartiles and Selected Deciles of Usual Weekly Earnings of Full-Time Wage and Salary Workers by Selected Characteristics, 2014 Annual Averages.” Accessed April 1, 2015. http://www.bls.gov/news.release/wkyeng.t09.htm.

Questions & Answers

price elasticity of demand is the degree of responsiveness of a quantity demanded to the change in price of the commodity in question.
Gladys Reply
what is the importance of learning economics?
Thelma Reply
it helps to make the correct choice
Gladys
it helps firm to produce products that will bring more profit
Gladys
the difference between needs and wants
londiwe Reply
needs are things that we basically can't live without wants are just luxury things
Thelma
needs are things without them we can't live but want are things without we can live
KP
what is education
KP
it's a process in which we give or receiving methodical instructions
Thelma
what is mixed economy
Amex
what is a deadweight loss? how monopoly creates a deadweight loss?
Ashraf Reply
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Lamine
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Cleaford
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nura
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Cleaford
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Dope
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Dope
hi y'all
Dope
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Dope
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Dope
to learn from one another
Lamine
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Dope
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Creative
Yes
Lamine
what is type of economic
taiwo Reply
how to understand basics of economics
Aarif Reply
what is demand schedle
Princess Reply
When you make a Scedule of the demand you made
Rodeen
this is helpful for rbi grade b
Prema Reply
What is macroeconomics
Kauna Reply
It's one of the two branches of Economics that deal with the aggregate economy.
Mayen
it's about inflation, occupation, gdp and so on
alberto
What is differences between Microeconomics and Macroeconomic?
Bethrand
microeconomics focuses on the action of individual agents in the economy such as businesses, workers and household. while macroeconomics looks at the economy as a whole. it focuses on broad issues in the economy such as government deficit, economy growth, levels of exports and imports, and
Thelma
inflationary increase in prices
Thelma
a price floor of 24 imposed
Annie Reply
monopolistic competition
bintu Reply
yap
nura
any one there to answer my question
Richard Reply
Fixed Costs per week Variable Costs per bear Rent & Rates of Factory Hire & machines Heating & Lighting Repayment of Bank Loan K100.00 K45.00 K5.00 K50.00 Materials Foam Wages K6.00 K1.00 K1.00 Total K200.00 K8.00
Richard
one of the scarce resources that constrain our behaviour is time. each of us has only 24 hours in a day. how do you go about allocating your time in a given day among completing alternatives? once you choose a most important use of time. why do you not spend all your time to it. use the notion of op
naknak Reply
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Dipam Reply
mani Baba. First learn the spelling of Economics
Dipam Reply
Economics- The study of how people use their limited resources to tey and satisfy unlimited wants.
Kelly
hmmm
Mani
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Mohsina

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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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