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how do external factors impact economic growth | external factors like global economic conditions international trade and geopolitical events can influence a country s economic growth rates positively or negatively exports for instance can boost growth while global recessions can hinder it | |
what are the potential downsides of high economic growth | high economic growth when not managed sustainably and equitably can lead to environmental degradation resource depletion and social challenges it may also exacerbate income inequality if not accompanied by inclusive policies | |
what is the relationship between inflation and economic growth | moderate inflation can be a sign of a healthy growing economy however high or volatile inflation can erode purchasing power create uncertainty and hinder economic growth by reducing consumer and investor confidence the bottom lineeconomic growth rate measures the percentage change in a country s economy often in gdp over a specific period it indicates whether an economy is expanding or contracting serving as a critical indicator of its performance factors like investment technological progress a skilled labor force entrepreneurship and sound economic policies influence economic growth rates | |
what is an economic indicator | an economic indicator is a piece of economic data usually of macroeconomic scale that is used by analysts to interpret current or future investment possibilities these indicators also help to judge the overall health of an economy while there are many different economic indicators specific pieces of data released by the government and non profit organizations have become widely followed such indicators include but aren t limited to the consumer price index cpi gross domestic product gdp or unemployment figures investopedia candra hufftypes of economic indicatorseconomic indicators can be divided into categories or groups most of these have a specific schedule for release allowing investors to prepare for and plan on seeing information at certain times of the month and year leading indicators such as the yield curve consumer durables net business formations and share prices are used to predict the future movements of an economy the numbers or data on these financial guideposts will move or change before the economy thus their category s name consideration of the information from these indicators must be taken with a grain of salt as they can be incorrect investors are most often interested in leading indicators as a correctly placed leading indicator can accurately predict future trends leading indicators may make broad economic assumptions for example many investors track forward looking yield curves to project how future interest rates may dictate stock or bond performance this analysis relies on historical data based on how investments performed the last time the yield curve was a certain way some may assume those same investments may repeat their performance coincident indicators which include such measures as gdp employment levels and retail sales are seen with the occurrence of specific economic activities this class of metrics shows the activity of a particular area or region many policymakers and economists follow this real time data as it provides the most insight into what is currently happening these types of indicators also allow for policymakers to leverage real time data without delay to make informed decisions coincident indicators may be somewhat less helpful to investors as the economic situation unfolds simultaneously as opposed to a forecast or a prediction a coincident indicator informs investors of what is actually happening in the present therefore coincident indicators may only be useful to those who can correctly interpret how economic conditions today i e falling gdp will impact future periods lagging indicators such as gross national product gnp cpi unemployment rates and interest rates are only seen after a specific economic activity occurs as the name implies these data sets show information after events have happened such trailing indicators are technical indicators that come after large economic shifts one drawback of lagging indicators is that a strategy developed in response to such indicators may arrive later than optimal for example by the time the federal reserve interprets cpi data and decides how best to enact monetary policy to stem inflation the numbers it is observing can be slightly outdated though lagging indicators are still used by many governments and institutions they also pose the risk of guiding incorrect decision making due to erroneous assumptions about present day economics indicators provide signs along the road but the best investors utilize many economic indicators combining them to glean insight into patterns and verifications within multiple sets of data interpreting economic indicatorsan economic indicator is only useful if one interprets it correctly history has shown strong correlations between economic growth as measured by gdp and corporate profit growth however determining whether a specific company may grow its earnings based on one indicator of gdp is nearly impossible there is no denying the objective importance of interest rates gross domestic product existing home sales or other indexes the indicators reflect the cost of money spending investment and the activity level of a major portion of the overall economy like many other forms of financial or economic metrics economic indicators hold tremendous value when compared across a period of time for example governments may observe how unemployment rates have fluctuated over the past five years a single instance of unemployment rates doesn t yield much value however comparing it to prior periods allows analysts to better understand the issue as a whole in addition many economic indicators have a benchmark set whether by a government agency or other entity consider how the federal reserve s target rate of inflation is usually 2 the federal reserve then enacts policies based on cpi measurements to achieve this target without this benchmark analysts and policymakers wouldn t know what makes a indicator s value good or poor the stock market as an indicatorleading indicators forecast where an economy is likely headed one of the top leading indicators is the stock market because stock prices factor in forward looking performance the market can indicate the economy s direction if earnings estimates are accurate a strong market may suggest that earnings estimates are up which may suggest overall economic activity is up conversely a down market may indicate that company earnings are expected to suffer however there are limitations to the usefulness of the stock market as an indicator because the relationship between performance and estimates is not guaranteed stocks are also subject to price manipulations caused by wall street traders and corporations manipulations can include inflating stock prices via high volume trades complex financial derivative strategies and creative accounting principles both legal and illegal the stock market is also vulnerable to the emergence of bubbles akin to false positives regarding the market s direction if you re particularly interested in a specific economic indicator released monthly by the government be aware that reports are often released on the same day of every month at the same time advantages and disadvantages of economic indicatorseconomic indicators rely on data to substantiate predictions of what is to come in the future when analyzed correctly investors can capitalize on data to make successful trades or correctly assess future market conditions economic indicators are often free and publicly accesible in addition economic indicators reported by governments often have a fixed cadence and steady form of measurement this means you can usually rely on the method of how an indicator was calculated and the timing of when that indicator will be released a downside to economic indicators particularly leading or coincident indicators is that they rely on some degree of forecasting while leading indicators are projections to the future even coincident indicators rely on some assumptions such indicators do not always predict the future correctly and the actions they recommend may not play out as expected economic indicators when boiled down to a single number can also fail to capture complex realities for example consider all of the variables that contribute to the unemployment rate this can include a wide range of influences from macroeconomic conditions to minor details like weather patterns as an indicator the unemployment rate may not fully encapsulate all the factors contributing to an issue finally economic indicators are somewhat open to interpretation consider an example where inflation has dropped from 4 6 to 4 5 is this considered a good change or should the drop have been larger economists and policymakers often debate the appropriate approach for interpreting economic data though the numbers may be concrete different interpretations may lead to drastically divergent conclusions may accurately forecast what is to come based on prevailing dataoften use publicly available informationmay be calculated using the same process over and over particularly when issued by governmentsmay be released on a fixed predictable cadencemay not accurately predict the futurerely on many assumptions some of which may be unpredictablecan be open for interpretationstill require expertise to interpret and understand | |
what is the most important economic indicator | every economist may come up with their own favorite economic indicator for many a country s gdp usually represents the best overall picture of a country s economic health it combines the monetary value of every good and service produced in an economy for a certain period and it considers household consumption government purchases and imports and exports | |
is inflation an economic indicator | yes inflation is a lagging indicator that is reported after a rise in prices has occurred this type of economic indicator is helpful for government agencies to set public policy as without this type of data they would not know the direction of the economy therefore while inflation and other lagging indicators are still useful to investors they are especially critical for developing future policy responses | |
what are the economic indicators of a strong economy | an economy may be strong if it has a robust amount of economic activity and job growth this is measured by low unemployment steady inflation increases to construction positive consumer index readings and increasing gdp | |
do traders use economic indicators | traders and investment professionals may use economic indicators to predict how broad economic policy will impact their trades or investment strategy the bottom lineeconomic indicators are leading coincident or lagging figures that indicate broad conditions economic indicators such as gdp unemployment inflation or certain prices inform policymakers individuals companies and investors of not only where the economy is today but perhaps where the economy may be headed economic indicators can be used to guide government policy or set investment strategies | |
what is economic integration | economic integration is an arrangement among nations that typically includes the reduction or elimination of trade barriers and the coordination of monetary and fiscal policies economic integration aims to reduce costs for both consumers and producers and to increase trade between the countries involved in the agreement 1economic integration is sometimes referred to as regional integration as it often occurs among neighboring nations economic integration explained | |
when regional economies agree on integration trade barriers fall and economic and political coordination increases | specialists in this area define seven stages of economic integration a preferential trading area a free trade area a customs union a common market an economic union an economic and monetary union and complete economic integration 2 the final stage represents a total harmonization of fiscal policy and a complete monetary union the advantages of economic integration fall into three categories trade creation employment opportunities and consensus and cooperation 1more specifically economic integration typically leads to a reduction in the cost of trade improved availability of goods and services a wider selection of them and gains in efficiency that lead to greater purchasing power economic integration can reduce the costs of trade improve the availability of goods and services and increase consumer purchasing power in member nations 1employment opportunities tend to improve because trade liberalization leads to market expansion technology sharing and cross border investment political cooperation among countries also can improve because of stronger economic ties which provide an incentive to resolve conflicts peacefully and lead to greater stability despite the benefits economic integration has costs these fall into three categories because economists and policymakers believe economic integration leads to significant benefits many institutions attempt to measure the degree of economic integration across countries and regions the methodology for measuring economic integration typically involves multiple economic indicators including trade in goods and services cross border capital flows labor migration and others assessing economic integration also includes measures of institutional conformity such as membership in trade unions and the strength of institutions that protect consumer and investor rights real world example of economic integrationthe european union eu was created in 1993 and included 27 member states in 2024 since 1999 20 of those nations have adopted the euro as a shared currency 3 according to data from the world bank the eu accounted for roughly 16 6 of the world s gross domestic product in 2022 4the united kingdom voted in 2016 to leave the eu in january 2020 british lawmakers and the european parliament voted to accept the united kingdom s withdrawal the uk officially split from the eu on january 1 2021 5 | |
what are examples of economic integration | there are numerous examples of economic integration around the world in north america the united states mexico canada agreement uscma is an example of a free trade agreement between the three countries the asia pacific economic cooperation is a forum of 21 pacific rim countries aimed at fostering free trade across the region as mentioned above the eu is another such example of economic integration as is the eurasian economic union eaeu | |
what are risks of economic integration | economic integration can come with downsides and risks primarily countries participating in regional integration may have divergent priorities when it comes to fiscal and monetary policy resolving such conflicts can be challenging and costly in terms of time and resources in addition economic integration can create a system in which a select group of stakeholders reap the economic benefits such as more revenue from trade while others bear the costs such as job market shifts these are important considerations to weigh when assessing the value of economic integration | |
what are benefits of economic integration | economic integration can increase trade benefiting both producers consumers and involved countries for instance with the elimination of trade barriers a firm may be able to produce and sell more products earning more revenue and increasing their home country s gross domestic product gdp for customers in other countries they can count on having more product selection and potentially lower costs as well the bottom lineeconomic integration is a form of coordination between different states in which barriers to trade are eliminated and fiscal and monetary policies are harmonized these arrangements can lead to increased economic activity job creation and stronger political ties they may also come with drawbacks such as trade diversion and loss of national sovereignty the eu is a well known example of regional economic integration as it is comprised of 27 member states 20 of which use the same currency | |
what is economic justice | economic justice is a component of social justice and welfare economics it is a set of moral and ethical principles for building economic institutions where the ultimate goal is to create an opportunity for each person to establish a sufficient material foundation upon which to have a dignified productive and creative life understanding economic justicethe concept of economic justice intersects with the idea of overall economic prosperity there is a belief that creating more opportunities for all members of society to earn viable wages will contribute to sustained economic growth when more citizens are able to provide for themselves and maintain stable discretionary income they are more likely to spend their earnings on goods which in turn drives demand in the economy achieving economic justice can include addressing wage gaps and other deficiencies in individual earnings for instance there are members of the workforce employed in jobs that do not make full use of their skills this typically leads to workers earning wages that do not reflect the full potential of their abilities as a result they do not have the highest income they are capable of earning such loss of possible wages creates an inefficiency in the economy because those workers will not have the income to participate to their fullest in it if this inefficiency reaches significant magnitude wherein large portions of the population are not purchasing goods and services they might have otherwise spent their earnings on it can slow the economy examples of ways to achieve economic justiceone attempt to achieve economic justice is a system of progressive taxation wherein the tax percentage increases as the base income amount increases the goal of progressive taxation is to remedy income inequality and provide funds for social services public infrastructure and education the earned income tax credit eitc affordable housing and need based federal financial aid for college students are other examples of economic justice institutions actions that could serve economic justice also include efforts to end gender driven wage gaps and provide more thorough career preparation and education to low income and at risk segments of the population elevating wages for workers who have been earning lower wages is another proposed method of serving economic justice such a strategy can be seen as a counterpoint to the idea of paying greater salaries to business executives who are associated with generating the wealth that pays the wages of others note that this idea doesn t operate in reverse when the economy experiences a downturn it is those who are among the poorest who face the most severe detriments compared with those who are more affluent | |
what is the goal of economic justice | economic justice strives to eliminate the inequality created by capitalism by creating equal opportunities for all members of the economy proponents argue that giving everyone a chance to earn a decent fair income is good for the economy as putting more money in pockets leads to greater spending on goods and services | |
what is the difference between social justice and economic justice | economic justice is about money and making sure everyone has an equal share social justice is concerned with equal rights in general for people of all social dimensions the idea behind social justice is that all people should have equal access to wealth health well being justice privileges and opportunity regardless of their legal political economic or other circumstances | |
is economic justice achievable | pure economic justice is a rarity many developed economies offer some form of welfare and implement a progressive taxation system to ensure that bigger earners contribute more to public finances however in most of these countries inequality is still widespread loopholes that favor the wealthy undermine attempts to reduce inequality and big businesses often threaten to relocate elsewhere if forced to share a greater portion of their earnings with employees | |
what is economic life | economic life is the expected period of time during which an asset remains useful to the average owner when an asset depreciates to the point it is no longer useful to its owner then it is said to be past its economic life the economic life of an asset could be different than its actual physical life thus an asset can be in optimal physical condition but may not be economically useful for example technology products often become obsolete when their technology becomes obsolete the obsolescence of flip phones occurred due to the advent of smartphones and not because they ran out of utility estimating the economic life of an asset is important for businesses so that they can determine when it s worthwhile to invest in new equipment allocating appropriate funds to purchase replacements once the equipment s useful life is met understanding economic lifethe economic life of an asset under the generally accepted accounting principles gaap requires a reasonable estimate of the time involved businesses can shift their measurements based on the anticipated daily usage and other factors the concept of economic life is also connected to depreciation schedules accounting standard setting bodies usually set generally accepted guidelines for estimating and adjusting this time period finance and economic lifefinancial considerations regarding the economic life of an asset include the cost at the time of purchase the amount of time the asset can be used in production the time at which it will need to be replaced and the cost of maintenance or replacement changes in industry standards or regulations may also be involved new regulations may render current equipment obsolete or raise the required industry standards for an asset beyond the specifications of a business s existing assets further the economic life on one asset may be tied to the useful life of another in cases where two separate assets are required to complete a task the loss of one asset may render the second asset useless until the first asset is repaired or replaced economic life and depreciationdepreciation refers to the rate at which an asset deteriorates over time the depreciation rate is used to estimate the effects of aging daily use and wear and tear on the asset when related to technology depreciation can also include the risk of obsolescence in theory businesses recognize depreciation expenses on a schedule that approximates the rate at which economic life is used up this is not always true for tax purposes however as owners may have superior information about specific assets the economic life used in internal calculations may differ significantly from the depreciable life required for tax purposes many businesses evaluate depreciation expenses differently based on management s goals for example a business might want to recognize costs as quickly as possible in order to minimize current tax liabilities and may do this by choosing accelerated depreciation schedules | |
what is economic order quantity eoq | economic order quantity eoq is the ideal quantity of units a company should purchase to meet demand while minimizing inventory costs such as holding costs shortage costs and order costs this production scheduling model was developed in 1913 by ford w harris and has been refined over time the economic order quantity formula assumes that demand ordering and holding costs all remain constant investopedia jessica olahformula for economic order quantity eoq the formula for eoq is | |
what economic order quantity eoq can tell you | the goal of the eoq formula is to identify the optimal number of product units to order if achieved a company can minimize its costs for buying delivering and storing units the eoq formula can be modified to determine different production levels or order intervals and corporations with large supply chains and high variable costs use an algorithm in their computer software to determine eoq eoq is an important cash flow tool the formula can help a company control the amount of cash tied up in the inventory balance for many companies inventory is its largest asset other than its human resources and these businesses must carry sufficient inventory to meet the needs of customers if eoq can help minimize the level of inventory the cash savings can be used for some other business purpose or investment the eoq formula determines the inventory reorder point of a company when inventory falls to a certain level the eoq formula if applied to business processes triggers the need to place an order for more units by determining a reorder point the business avoids running out of inventory and can continue to fill customer orders if the company runs out of inventory there is a shortage cost which is the revenue lost because the company has insufficient inventory to fill an order an inventory shortage may also mean the company loses the customer or the client will order less in the future example of how to use economic order quantity eoq eoq takes into account the timing of reordering the cost incurred to place an order and the cost to store merchandise if a company is constantly placing small orders to maintain a specific inventory level the ordering costs are higher and there is a need for additional storage space assume for example that a retail clothing shop carries a line of men s jeans and the shop sells 1 000 pairs of jeans each year it costs the company 5 per year to hold a pair of jeans in inventory and the fixed cost to place an order is 2 the eoq formula is the square root of 2 x 1 000 pairs x 2 order cost 5 holding cost or 28 3 with rounding the ideal order size to minimize costs and meet customer demand is slightly more than 28 pairs of jeans a more complex portion of the eoq formula provides the reorder point limitations of economic order quantity eoq the eoq formula assumes that consumer demand is constant the calculation also assumes that both ordering and holding costs remain constant this fact makes it difficult or impossible for the formula to account for business events such as changing consumer demand seasonal changes in inventory costs lost sales revenue due to inventory shortages or purchase discounts a company might realize for buying inventory in larger quantities | |
what is the economic order quantity | economic order quantity is an inventory management technique that helps make efficient inventory management decisions it refers to the optimal amount of inventory a company should purchase in order to meet its demand while minimizing its holding and storage costs one of the important limitations of the economic order quantity is that it assumes the demand for the company s products is constant over time | |
when is economic order quantity high and low | economic order quantity will be higher if the company s setup costs or product demand increases on the other hand it will be lower if the company s holding costs increase | |
why is economic order quantity important | economic order quantity is important because it helps companies manage their inventory efficiently without inventory management techniques such as these companies will tend to hold too much inventory during periods of low demand while also holding too little inventory during periods of high demand either problem creates missed opportunities the bottom linemanaging inventory is a key component of success for a company having too much inventory results in higher costs that take away from profits due to the cost of maintaining inventory and sometimes having to discard old inventory having too little inventory means a company is losing out on sales by not meeting demand economic order quantity helps ensure companies manage their inventories efficiently | |
what is economic profit | an economic profit is the difference between the revenue received from sales and the explicit costs of producing its goods and services as well as any opportunity costs opportunity costs are a type of implicit cost determined by management and will vary based on different scenarios and perspectives investopedia mira norianunderstanding economic profiteconomic profit is often analyzed in conjunction with accounting profit accounting profit is the profit that a company shows on its income statement it is also known as net income accounting profit measures actual money inflows versus money outflows and is part of the required financial reporting and transparency of a company economic profit on the other hand is not recorded on a company s financial statements nor is it required to be disclosed to regulators investors or financial institutions economic profit can be used in a what if analysis companies and individuals may choose to consider economic profit when they are faced with choices involving production levels or other business alternatives economic profit can provide a proxy for foregone profit considerations the calculation for economic profit can vary by entity and scenario in general it can be captured as follows if you excluded the opportunity costs from this equation you d get simply the accounting profit however when you subtract the opportunity costs as well the economic profit results it can serve as a comparison to other options that could have been undertaken by a company for better or worse companies state their explicit costs on the income statement the accounting profit on the bottom line of the income statement is the net income after subtracting for direct indirect and capital costs the cost of goods sold is the most basic explicit cost used in analyzing per unit costs thus in the equation above a company could also break down its opportunity costs by units to arrive at a per unit economic profit individuals starting their own business might use economic profit as a proxy for their first year of business since they have given up some prior opportunity with large entities business managers can potentially look more intricately at gross operating and net profit versus economic profit at different phases of the business operations economic profit vs accounting profitaccounting profit or net income is determined by subtracting all costs from revenue for a particular accounting period economic profit is determined by going a step further and subtracting opportunity costs as well the former represents an actual figure that s included on financial statements the latter can be used by company management to determine how effective its business decisions were it can also be used before actions are taken to decide on the best business strategy to put to work here s a quick reference chart that summarizes the differences between economic profit and accounting profit advantages and disadvantages of economic profitspecial considerationsopportunity costs can be used for deeper analysis of business decisions specifically when alternatives are available companies may look at opportunity costs when considering production levels for different types of products that they produce collectively but in varying quantities opportunity costs are somewhat arbitrary and are a type of implicit cost they can vary depending on management s estimations and market circumstances generally opportunity cost will be the accounting profit that could have been achieved by making an alternative choice examples of economic profitan individual starts a business and incurs startup costs of 100 000 during the first year of operation the business earns revenue of 120 000 this results in an accounting profit of 20 000 however if the individual had stayed at her previous job she would have made 45 000 in this example the individual s economic profit is equal to this calculation only considers the first year of business if after the first year costs decrease to 10 000 then the economic profit outlook would improve for future years if economic profit comes out to zero the company is said to be in a state of normal profit in using economic profit in comparison to gross profit a company may look at different types of scenarios in this case gross profit is the focus and a company would subtract the opportunity cost per unit if a company generates 10 per unit from selling t shirts with a 5 cost per unit then its gross profit per unit for t shirts is 5 however if it could have produced shorts with revenue of 10 and costs of 2 then there would be an opportunity cost of 8 as well all things being equal the company could have earned 3 more per unit if they had produced shorts instead of t shirts thus the 3 per unit is considered an economic loss companies can use this type of analysis to decide on production levels more complex scenario analysis of profits may also factor in indirect costs or other types of implicit costs depending on the expenditures involved in doing business as well as different phases of a business cycle | |
what are economic profits | economic profits are the theoretical profits that result when company management subtracts all expenses plus the costs of lost opportunities from revenue earned in a particular period of time | |
why is economic profit important | it can be important because it can help a company s management understand potential flaws in its choices for business strategies or ventures missed financial opportunities and how efficiently it uses company resources | |
what is an opportunity cost | it s the cost to an individual or company of not pursuing a particular business option the cost isn t related to something they spend it refers to money they forego the bottom lineeconomic profit represents a company s revenue less its explicit costs as well as its opportunity costs it s used for internal analysis accounting profit net income is a company s revenue less its direct indirect and capital costs it s reported on financial statements and to the irs economic profit is important for the insight that it can give the management of a company about potential or past business opportunities accounting profit is an important measure of profitability and management capability for investors | |
what is economic profit | an economic profit is the difference between the revenue received from sales and the explicit costs of producing its goods and services as well as any opportunity costs opportunity costs are a type of implicit cost determined by management and will vary based on different scenarios and perspectives investopedia mira norianunderstanding economic profiteconomic profit is often analyzed in conjunction with accounting profit accounting profit is the profit that a company shows on its income statement it is also known as net income accounting profit measures actual money inflows versus money outflows and is part of the required financial reporting and transparency of a company economic profit on the other hand is not recorded on a company s financial statements nor is it required to be disclosed to regulators investors or financial institutions economic profit can be used in a what if analysis companies and individuals may choose to consider economic profit when they are faced with choices involving production levels or other business alternatives economic profit can provide a proxy for foregone profit considerations the calculation for economic profit can vary by entity and scenario in general it can be captured as follows if you excluded the opportunity costs from this equation you d get simply the accounting profit however when you subtract the opportunity costs as well the economic profit results it can serve as a comparison to other options that could have been undertaken by a company for better or worse companies state their explicit costs on the income statement the accounting profit on the bottom line of the income statement is the net income after subtracting for direct indirect and capital costs the cost of goods sold is the most basic explicit cost used in analyzing per unit costs thus in the equation above a company could also break down its opportunity costs by units to arrive at a per unit economic profit individuals starting their own business might use economic profit as a proxy for their first year of business since they have given up some prior opportunity with large entities business managers can potentially look more intricately at gross operating and net profit versus economic profit at different phases of the business operations economic profit vs accounting profitaccounting profit or net income is determined by subtracting all costs from revenue for a particular accounting period economic profit is determined by going a step further and subtracting opportunity costs as well the former represents an actual figure that s included on financial statements the latter can be used by company management to determine how effective its business decisions were it can also be used before actions are taken to decide on the best business strategy to put to work here s a quick reference chart that summarizes the differences between economic profit and accounting profit advantages and disadvantages of economic profitspecial considerationsopportunity costs can be used for deeper analysis of business decisions specifically when alternatives are available companies may look at opportunity costs when considering production levels for different types of products that they produce collectively but in varying quantities opportunity costs are somewhat arbitrary and are a type of implicit cost they can vary depending on management s estimations and market circumstances generally opportunity cost will be the accounting profit that could have been achieved by making an alternative choice examples of economic profitan individual starts a business and incurs startup costs of 100 000 during the first year of operation the business earns revenue of 120 000 this results in an accounting profit of 20 000 however if the individual had stayed at her previous job she would have made 45 000 in this example the individual s economic profit is equal to this calculation only considers the first year of business if after the first year costs decrease to 10 000 then the economic profit outlook would improve for future years if economic profit comes out to zero the company is said to be in a state of normal profit in using economic profit in comparison to gross profit a company may look at different types of scenarios in this case gross profit is the focus and a company would subtract the opportunity cost per unit if a company generates 10 per unit from selling t shirts with a 5 cost per unit then its gross profit per unit for t shirts is 5 however if it could have produced shorts with revenue of 10 and costs of 2 then there would be an opportunity cost of 8 as well all things being equal the company could have earned 3 more per unit if they had produced shorts instead of t shirts thus the 3 per unit is considered an economic loss companies can use this type of analysis to decide on production levels more complex scenario analysis of profits may also factor in indirect costs or other types of implicit costs depending on the expenditures involved in doing business as well as different phases of a business cycle | |
what are economic profits | economic profits are the theoretical profits that result when company management subtracts all expenses plus the costs of lost opportunities from revenue earned in a particular period of time | |
why is economic profit important | it can be important because it can help a company s management understand potential flaws in its choices for business strategies or ventures missed financial opportunities and how efficiently it uses company resources | |
what is an opportunity cost | it s the cost to an individual or company of not pursuing a particular business option the cost isn t related to something they spend it refers to money they forego the bottom lineeconomic profit represents a company s revenue less its explicit costs as well as its opportunity costs it s used for internal analysis accounting profit net income is a company s revenue less its direct indirect and capital costs it s reported on financial statements and to the irs economic profit is important for the insight that it can give the management of a company about potential or past business opportunities accounting profit is an important measure of profitability and management capability for investors | |
what was the economic recovery tax act of 1981 | the economic recovery tax act of 1981 erta was the largest tax cut in u s history signed by president ronald reagan about six months after he took office erta slashed the top income tax rate and allowed for faster expensing of depreciable assets it included incentives for small business and retirement savings and established inflation indexing of tax brackets understanding the economic recovery tax act of 1981erta was also known as the kemp roth tax cut after its republican sponsors representative jack kemp of new york and senator william v roth of delaware the biggest tax cuts were for wealthy americans with the top rate cut from 70 to 50 over three years the bottom bracket was cut from 14 to 11 besides tax cuts and accelerated depreciation deductions other features of the legislation included easier rules for establishing employee stock ownership plans esop expanded eligibility for individual retirement accounts iras a reduction in the capital gains tax from 28 to 20 and a higher estate tax exemption the indexing of tax brackets was a key provision given the era s double digit annual inflation which was pushing even lower and middle class families into higher brackets 12erta inspired by supply side economicsthe bill was inspired by supply side theories of economics advanced by economist and reagan adviser arthur laffer the basic idea was that cutting taxes on the wealthy would spur more capital investment and innovation with the benefits trickling down to average citizens through job growth and increased consumer spending in return tax revenues would rise as the economy boomed but erta did not immediately jumpstart the economy as proponents expected business capital investment remained anemic unemployment stayed high and consumer spending did not increase meanwhile in the year after the bill s passage the federal deficit spiked due to the drastic decline in tax revenue congress blunts erta a year laterby the time erta became law the second half of the double dip recession was beginning in the u s partly because federal reserve chair paul volcker was determined to quash inflation with the benchmark interest rate as high as 20 with the economy tanking and tax revenue sinking the u s deficit began to soar an alarmed congress responded by reversing some of the provisions in the erta in september of 1982 with the tax equity and fiscal responsibility act led by senate finance committee chair robert dole recovery began almost immediately the erta remains controversial growth did rebound in the mid and late 1980s and proponents cited the tax cuts as the reason why although it is unlikely to be the final word in 2012 the non partisan congressional research service analyzed tax rates and their economic effects from 1940 to 2010 and concluded that lowering top tax rates has no effect on economic growth or productivity but does contribute to greater wealth inequality 3 under reagan the u s national debt tripled to 2 6 trillion 4 | |
what is economic rent | economic rent is an amount of money earned that exceeds that which is economically or socially necessary this can occur for example when a buyer working to attain a good or service that is considered exclusive makes an offer prior to hearing what a seller considers an acceptable price market imperfections thus lead to the rise of economic rent it would not exist if markets were perfect since competitive pressures would drive down prices understanding economic renteconomic rent should not be confused with normal profit or surplus that arises in the course of competitive capitalist production this term also differs from the traditional use of the word rent which applies to payments received in exchange for the temporary use of a particular good or property such as land or housing economic rent can also occur when certain producers in a competitive market have asymmetric information or technologically advanced production systems give them a competitive advantage as a low cost producer that other firms lack or are not capable of acquiring competitive advantages built up over time due to economic rent can often lead to a lack of competition and entrenched ways of doing business updating rules and regulations are often looked to by governments and by associated agencies as a reliable method for reducing economic rent and promoting healthy competition on oct 5 2021 the testimony of gary gensler the current chair of the u s securities and exchange commission sec before the u s senate committee on banking housing and urban affairs espoused the qualities of the u s financial system that make it a world leader he went on to note that updates to sec rules are needed to keep up with changes in technology and to ensure that the markets are as efficient and competitive as possible gensler s testimony clearly highlights the strive for balance between current levels of american competitiveness and the desire to reduce economic rent 1economic rent can also arise from conditions of scarcity and can be used to demonstrate numerous pricing discrepancies these include higher pay for unionized workers compared with nonunionized workers or huge salaries made by a star athlete vs an average working individual economic rent also explains the high value of exclusive intangible assets such as patents and permits together these are also known as scarcity rents economic rent and labora worker may be willing to work for 15 per hour but because they belong to a union they receive 18 per hour for the same job the difference of 3 is the worker s economic rent which can also be referred to as unearned income in this regard unearned income refers to the amount offered that is above what the employee felt that their skills and abilities were worth in the current marketplace it can also apply when a person s skills would be valued less in an open market but they receive more due to an affiliation with a group such as a union that sets minimum standards of pay economic rent and facilitiesas another example the owner of a property in an exclusive shopping mall may be willing to rent it out for 10 000 per month but a company that is keen to have a retail storefront in the mall may offer 12 000 as monthly rent for the property to secure it and forestall competition the difference of 2 000 in this case is the owner s economic rent it can also refer to a situation in which two properties exist with the exact same features except for location if one location is preferable to another then the owner of the preferred location receives a higher payment than the other without having to complete any additional work the lack of additional labor on the part of the owner can also be considered unearned income other economic rent formsother forms of economic rent include information asymmetries in which an agent derives excess profits from having information not provided to the principal or the rest of the market contract rent refers to a situation wherein there is a mutually agreed upon deal between two parties but external conditions change over time granting one party unequal benefit usually at the expense of the other party monopoly rent refers to the situation in which a monopoly producer lacks competition and thus can sell its goods and services at a price far above what the otherwise competitive market price would be at the expense of consumers differential rent refers to the excess profit that may arise owing to differences in the fertility of the land the surplus that arises due to the difference between marginal land and intramarginal land is the differential rent it is generally accrued under conditions of extensive land cultivation differential ground rent was first proposed by the classical political economist david ricardo | |
what is an economic shock | an economic shock refers to any change to fundamental macroeconomic variables or relationships that has a substantial effect on macroeconomic outcomes and measures of economic performance such as unemployment consumption and inflation shocks are often unpredictable and are usually the result of events thought to be beyond the scope of normal economic transactions economic shocks have widespread and lasting effects on the economy and according to real business cycle theory rbc are thought to be the root cause of recessions and economic cycles understanding economic shockseconomic shocks can be classified as primarily impacting the economy through either the supply or demand side they can also be classified by their origin within or impact upon a specific sector of the economy finally shocks can be considered either real or nominal shocks depending on whether they originate from changes in real economic activity or changes in the nominal values of financial variables because markets and industries are interconnected in the economy large shocks to either supply or demand in any sector of the economy can have a far reaching macroeconomic impact economic shocks can be positive helpful or negative harmful to the economy though for the most part economists and normal people are more concerned about negative shocks types of economic shocksa supply shock is an event that makes production across the economy more difficult more costly or impossible for at least some industries a rise in the cost of important commodities such as oil can cause fuel prices to skyrocket making it expensive to use for business purposes natural disasters or weather events such as hurricanes floods or major earthquakes can induce supply shocks too as can man made events such as wars or major terrorism incidents economists sometimes refer to most supply side shocks as technological shocks 1demand shocks happen when there is a sudden and considerable shift in the patterns of private spending either in the form of consumer spending or investment spending from businesses an economic downturn in the economy of a major export market can create a negative shock to business investment particularly in export industries a crash in stock or home prices can cause a negative demand shock as households react to a loss of wealth by cutting back sharply on consumption spending 2 supply shocks to consumer commodities with price inelastic demand such as food and energy can also lead to a demand shock by reducing consumers real incomes economists sometimes refer to demand side shocks as non technological shocks 3a financial shock is one that originates from the financial sector of the economy because modern economies are so deeply dependent on the flow of liquidity and credit to fund normal operations and payrolls financial shocks can impact every industry in an economy a stock market crash a liquidity crisis in the banking system unpredictable changes in monetary policy or the rapid devaluation of a currency would be examples of financial shocks financial shocks are the primary form of nominal shocks though their effects clearly can have a serious impact on real economic activity policy shocks are changes in government policy that have a profound economic effect the economic impact of a policy shock might even be the goal of a government action it could be an expected side effect or an entirely unintended consequence as well fiscal policy is in effect a deliberate economic demand shock positive or negative intended to smooth out aggregate demand over time the imposition of tariffs and other barriers to trade can create a positive shock for domestic industries but a negative shock to domestic consumers sometimes even a potential change in policy or an increase in uncertainty about future policy can create an economic shock before or without an actual policy change a technology shock results from technological developments that affect productivity the introduction of computers and internet technology and the resulting increase in productivity across many different occupations is an example of a positive technology shock economists often use the term technology in a much broader sense so that many of the above examples of economic shocks such as a rise in energy prices would also fall under the category of technology shocks however people also often refer to shocks specifically originating from the technology sector as technology shocks | |
economic stimulus is action by the government to encourage private sector economic activity to stimulate the economy the government adopts targeted expansionary policies | economic stimulus in the united states may be related to monetary policy carried out by the federal reserve other forms of economic stimulus are driven by fiscal policy with lawmakers directing tax policies and government spending toward areas that they believe will jump start the economy policy tools for implementing economic stimulus include lowering interest rates increasing government spending and the purchase of assets by the central bank in a process known as quantitative easing it is common for the government to adopt stimulus policies during times of recession but economic stimulus may also be used to provide an additional boost during periods of economic strength although the long term benefits of such policies remain a subject of debate the programs put in place to bolster the economy can have a big impact on financial markets and investors this makes it important to be aware of the mechanisms of economic stimulus as well as the associated benefits and risks | |
how economic stimulus works | over the course of a normal business cycle governments try to influence the pace and composition of economic growth using various tools at their disposal central governments including the u s federal government use fiscal and monetary policy tools to stimulate growth state and local governments can also engage in projects or policies that stimulate private sector investment economic stimulus refers to a targeted and conservative approach to expansionary economic policy instead of using monetary and fiscal policy to replace private sector spending economic stimulus is supposed to direct government deficit spending tax cuts lowered interest rates or new credit creation toward key sectors of the economy to take advantage of powerful multiplier effects that will indirectly increase private sector consumption and investment spending proponents of economic stimulus believe that this increased private sector spending will then boost the economy out of recession the goal is to achieve this stimulus response effect so that the private sector can do most of the work to fight the recession and to avoid risks such as hyperinflation or government defaults that might come with massive government deficits or extreme monetary policy by stimulating private sector growth stimulus deficit spending could allegedly even pay for itself through higher tax revenues resulting from faster growth 1fiscal stimulus refers to policy measures undertaken by a government that typically reduce taxes or regulations or increase government spending to boost economic activity monetary stimulus on the other hand refers to central bank actions such as lowering interest rates or purchasing securities in the market to make it easier or cheaper to borrow and invest a stimulus package is a coordinated combination of fiscal and monetary measures put together by a government to stimulate a floundering economy 2the concept of economic stimulus is associated with 20th century economist john maynard keynes a recession according to keynesian economics is a deficiency of aggregate demand where the economy will not self correct and reaches a new equilibrium with higher unemployment lower output and slower growth rates under this theory to combat recession the government should aim to restore aggregate demand and full employment through policies that make up for shortfalls in private sector consumption and business investment spending 34risks of economic stimulusthere are several counterarguments regarding the efficiency and long term benefits of economic stimulus some theorists believe that economic stimulus can actually delay or prevent private sector recovery from the actual cause of a recession according to this viewpoint it is misguided to target economic stimulus toward industries that are hardest hit by the recession because these are precisely the areas of the economy that may need to be cut back to adjust to real economic conditions other critiques about the effectiveness of economic stimulus revolve around how people respond to economic incentives economists have argued that consumers and businesses adjust their behavior in ways that offset the stimulus policy the response to the stimulus will not be a simple multiplier effect but will also include these offsetting behaviors one such theory is ricardian equivalence named for david ricardo s work dating back to the early 1800s which suggests that consumers internalize government spending decisions in a way that counterbalances stimulus measures in other words ricardo argued that consumers will spend less today if they believe they will pay higher future taxes to cover government deficits 5other critics of economic stimulus point to the crowding out of private investment the crowding out critique suggests that government deficit spending will reduce private investment in two ways examples of economic stimulus programsthose who have lived through the past few decades have had quite a few chances to see economic stimulus in action the economic shockwaves from the financial crisis of 2007 2008 and more recently the covid 19 pandemic forced fiscal and monetary policymakers into action the programs below represent just a small sampling of government efforts to steer the economy through the respective crises but they offer some insights into the potential benefits and shortcomings of economic stimulus policymakers often attempt to direct the benefits of economic stimulus toward specific industries or sectors when the u s auto industry struggled during the great recession the government instituted the cash for clunkers program which incentivized consumers to buy new fuel efficient vehicles to replace their old cars signed into law by then president barack obama and lasting for a short time frame in the summer of 2009 until its allocated funding was depleted cash for clunkers was intended to be a win win by stimulating a critical industry during the recession while also reducing pollution 6however critics argued that cash for clunkers led to a used vehicle shortage and higher car prices with much of the benefit going to foreign car manufacturers 78 the program succeeded in nudging consumers to trade in their gas guzzlers but it may have simply pushed forward a transaction that was going to happen anyway and the economic effect was short lived 9 even the environmental impact was mixed as the discarded clunkers generated hazardous waste from metal shredding and the program did not represent a cost effective way to cut emissions 10the coronavirus aid relief and economic security cares act signed into law by then president donald trump on march 27 2020 aimed to counteract the economic turmoil set into motion by the global covid 19 pandemic with concerns that the u s economy was heading into a recession policymakers passed a record 2 2 trillion stimulus bill to support large and small businesses industries individuals families gig workers independent contractors and the healthcare system 11the cares act took a multifaceted approach to stimulate the ailing economy during the early stages of the pandemic the legislation put money directly into the pockets of u s consumers authorizing direct stimulus payments of 1 200 per adult plus 500 per child for households making up to 75 000 with additional tax rebates for families with children the stimulus package also boosted unemployment benefits and helped small businesses hold onto their employees as far as targeting individual hard hit industries and sectors the cares act directed billions toward airlines to keep planes in the skies throughout the pandemic 11in addition to standing out for its massive price tag the cares act pushed the boundaries of economic stimulus by directly replacing large swaths of private sector spending that had been destroyed by the coronavirus 11 while the cares act may have been a needed response to the unprecedented economic shock of the pandemic the long term impact of the stimulus package remains difficult to quantify | |
how is the economy stimulated | the government can stimulate the economy through targeted expansionary monetary and fiscal policy the idea of economic stimulus is that these actions by the government help to jump start economic activity in the private sector policy tools for stimulating the economy include interest rate cuts government spending increases and quantitative easing policymakers generally direct stimulus programs toward key economic sectors to take advantage of multiplier effects that they hope will indirectly increase private sector spending | |
is stimulus good for the economy | economists continue to debate the usefulness of economic stimulus programs while stimulus efforts often have short term benefits of boosting demand and reinvigorating vital economic sectors the longer term effects can be more difficult to quantify for instance an overstimulated economy could have the unintended consequence of crowding out private sector investment | |
when central banks like the u s federal reserve opt to engage in quantitative easing they buy securities from the market to increase the money supply this means that banks have more reserves on hand and the increased liquidity revitalizes lending and investing | the bottom lineeconomic stimulus can refer to monetary and fiscal policies that governments put in place to energize economic activity in the private sector policymakers aim stimulus efforts at critical areas of the economy with hopes that the multiplier effect will provoke broader economic growth there is still plenty of debate surrounding the long term impact of economic stimulus programs proponents argue that targeted economic stimulus can be a vital recession fighting tool that avoids the risks associated with more drastic measures meanwhile critics say that economic stimulus packages may have unpredictable and negative impacts in the long term | |
what is economic value | economic value is the value that person places on an economic good based on the benefit that they derive from the good it is often estimated based on the person s willingness to pay for the good typically measured in units of currency the economic value should not be confused with market value which is the market price for a good or service which can be higher or lower than the economic value that any particular person puts on a good understanding economic valuethe preferences of a given person determine the economic value of a good or service and the trade offs that they will be willing to make to obtain it for example if a person has an apple then the economic value of that apple is the benefit that they receive from their use of the apple if they intend to eat the apple then the economic value is the enjoyment and nutrition they expect to receive from eating the apple the economic value of the apple does not exist as any objective quality of the apple but is entirely dependent on the subjective intention of the person valuing the apple and their relationship to it while the qualities of the apple might influence the use that the person has for the apple the sole source of economic value for the apple is the person s expectation of how well an apple of that given quality will suit their use economic value of consumer goodsbecause economic value is subjective and dependent on a person s intentions it cannot be directly measured various methods have been devised in order to try to quantify or estimate economic value however the classic method that economists use to estimate how much people value an economic good is to look at the price they pay for it when an individual buys a good they give up a given amount of money in return because they value both the good they receive and the money they give up based on their subjective intended use for the good or the money it is obvious from their choice to purchase the good that they must place a higher economic value on the good than on that amount of money thus the price that a person pays for a good provides one way to quantify the economic value of that good hedonic pricing is another way of estimating the economic value of a good hedonic pricing uses statistical regression analysis to estimate the economic value the people attach to the various specific attributes of a good based on past transactions because these attributes or qualities of the good are what determine how well the good will suit an individual s intended use for the good they will indirectly influence the economic value of the good economists can create statistical models of how the attributes of similar goods have influenced the price of similar goods in past transactions and use these to estimate the economic value of a given good based on it s attributes companies use the economic value to the customer evc to set prices for their products or services evc is not derived from a precise mathematical formula but it considers the tangible and intangible value of a product the tangible value is based on the product s functionality and the intangible value is based on consumer sentiment toward product ownership for example a consumer places a tangible value on a durable pair of sneakers that provide protection and support during athletic activity however the sneaker s brand label or affiliation with a celebrity can add intangible value to the sneakers marketer can use surveys focus groups or other tools so get an idea of how much value consumers will place on the sneakers based on their characteristics | |
what is economic value added eva | economic value added eva is a measure of a company s financial performance based on the residual wealth calculated by deducting its cost of capital from its operating profit adjusted for taxes on a cash basis eva can also be referred to as economic profit as it attempts to capture the true economic profit of a company this measure was devised by management consulting firm stern value management originally incorporated as stern stewart co understanding economic value added eva eva is the incremental difference in the rate of return ror over a company s cost of capital essentially it is used to measure the value a company generates from funds invested in it if a company s eva is negative it means the company is not generating value from the funds invested into the business conversely a positive eva shows a company is producing value from the funds invested in it the formula for calculating eva is eva nopat invested capital wacc | |
where | special considerationsthe equation for eva shows that there are three key components to a company s eva nopat the amount of capital invested and the wacc nopat can be calculated manually but is normally listed in a public company s financials capital invested is the amount of money used to fund a company or a specific project wacc is the average rate of return a company expects to pay its investors the weights are derived as a fraction of each financial source in a company s capital structure wacc can also be calculated but is normally provided the equation used for invested capital in eva is usually total assets minus current liabilities two figures easily found on a firm s balance sheet in this case the modified formula for eva is nopat total assets current liabilities wacc as noted by stern value management in 1983 the management team developed eva a new model for maximizing the value created that can also be used to provide incentives at all levels of the firm the goal of eva is to quantify the cost of investing capital into a certain project or firm and then assess whether it generates enough cash to be considered a good investment a positive eva shows a project is generating returns in excess of the required minimum return advantages and disadvantages of evaeva assesses the performance of a company and its management through the idea that a business is only profitable when it creates wealth and returns for shareholders thus requiring performance above a company s cost of capital eva as a performance indicator is very useful the calculation shows how and where a company created wealth through the inclusion of balance sheet items this forces managers to be aware of assets and expenses when making managerial decisions however the eva calculation relies heavily on the amount of invested capital and is best used for asset rich companies that are stable or mature companies with intangible assets such as technology businesses may not be good candidates for an eva evaluation | |
what is the economic value of equity eve | the economic value of equity eve is a cash flow calculation that takes the present value of all asset cash flows and subtracts the present value of all liability cash flows unlike earnings at risk and value at risk var a bank uses the economic value of equity to manage its assets and liabilities this is a long term economic measure used to assess the degree of interest rate risk exposure as opposed to net interest income nii which reflects short term interest rate risk the simplest definition of eve is the net present value npv of a bank s balance sheet s cash flows this calculation is used for asset liability management to measure changes in the economic value of the bank eve risk is defined as a bank s value sensitivity to changes in market rates understanding evethe economic value of equity is a cash flow calculation that subtracts the present value of the expected cash flows on liabilities from the present value of all expected asset cash flows this value is used as an estimate of total capital when evaluating the sensitivity of total capital to fluctuations in interest rates a bank may use this measure to create models that indicate how interest rate changes will affect its total capital the fair market values of a bank s assets and liabilities are directly linked to interest rates a bank constructs models with all constituent assets and liabilities that show the effect of different interest rate changes on its total capital this risk analysis is a key tool that allows banks to prepare against constantly changing interest rates and to perform stress tests an internationally accepted standard for determining interest rate risk is to stress test eve the basel committee on banking supervision recommends a plus and minus 2 stress test on all interest rates and us bank regulations require regular analysis of eve 12the economic value of equity should not be confused with the earnings profile of a bank a general rise in interest rates may boost earnings of a bank but it would normally cause a decrease in the economic value of equity because of the basic inverse relationship between asset values and interest rates and direct relationship same direction between values of liabilities and interest rates however eve and bank earnings do bear a relationship in that the higher the eve the greater the potential for increased future earnings generated from the equity base bank regulators require banks to conduct periodic eve calculations 1limitations of evewhile the net present value of a bond can be calculated quite easily future cash flows can be difficult to quantify for deposit accounts and other financial instruments that have no maturity because these types of products have uncertain duration and uneven cash flows eve modelers must make assumptions for certain liabilities which may deviate from reality in addition because eve is a comprehensive calculation complex products with embedded options are not easily modeled and leave wide room for interpretation and subjective judgement of the modelers or their supervisors | |
what is economics | economics is a social science that focuses on the production distribution and consumption of goods and services the study of economics is primarily concerned with analyzing the choices that individuals businesses governments and nations make to allocate limited resources economics has ramifications on a wide range of other fields including politics psychology business and law zoe hansen investopediaunderstanding economicsassuming humans have unlimited wants within a world of limited means economists analyze how resources are allocated for production distribution and consumption the study of microeconomics focuses on the choices of individuals and businesses and macroeconomics concentrates on the behavior of the economy on an aggregate level one of the earliest recorded economists was the 8th century b c greek farmer and poet hesiod who wrote that labor materials and time needed to be allocated efficiently to overcome scarcity the publication of adam smith s 1776 book an inquiry into the nature and causes of the wealth of nations sparked the beginning of the current western contemporary economic theories 1microeconomicsmicroeconomics studies how individual consumers and firms make decisions to allocate resources whether a single person a household or a business economists may analyze how these entities respond to changes in price and why they demand what they do at particular price levels microeconomics analyzes how and why goods are valued differently how individuals make financial decisions and how they trade coordinate and cooperate within the dynamics of supply and demand the costs of producing goods and services and how labor is divided and allocated microeconomics studies how businesses are organized and how individuals approach uncertainty and risk in their decision making macroeconomicsmacroeconomics is the branch of economics that studies the behavior and performance of an economy as a whole its primary focus is recurrent economic cycles and broad economic growth and development it focuses on foreign trade government fiscal and monetary policy unemployment rates the level of inflation interest rates the growth of total production output and business cycles that result in expansions booms recessions and depressions using aggregate indicators economists use macroeconomic models to help formulate economic policies and strategies | |
what is the role of an economist | an economist studies the relationship between a society s resources and its production or output and their opinions help shape economic policies related to interest rates tax laws employment programs international trade agreements and corporate strategies economists analyze economic indicators such as gross domestic product and the consumer price index to identify potential trends or make economic forecasts according to the bureau of labor statistics bls 38 of all economists in the united states work for a federal or state agency economists are also employed as consultants professors by corporations or as part of economic think tanks 2 | |
what are economic indicators | economic indicators detail a country s economic performance published periodically by governmental agencies or private organizations economic indicators often have a considerable effect on stocks employment and international markets they may predict future economic conditions that will move markets and guide investment decisions the gross domestic product gdp is considered the broadest measure of a country s economic performance it calculates the total market value of all finished goods and services produced in a country in a given year in the u s the bureau of economic analysis bea also issues a regular report during the latter part of each month 3 many investors analysts and traders focus on the advance gdp report and the preliminary report both issued before the final gdp figures because the gdp is considered a lagging indicator meaning it can confirm a trend but can t predict a trend the gdpnow forecasting model used by the federal reserve provides a nowcast of the official estimate before its release by estimating gdp growth using a methodology similar to the one used by the u s bureau of economic analysis 4reported by the u s department of commerce doc during the middle of each month the retail sales report measures the total receipts or dollar value of all merchandise sold in stores 5 sampling retailers across the country acts as a proxy of consumer spending levels consumer spending represents more than two thirds of gdp proving useful to gauge the economy s general direction 6the industrial production report released monthly by the federal reserve reports changes in the production of factories mines and utilities in the u s one measure included in this report is the capacity utilization rate which estimates the portion of productive capacity that is being used rather than standing idle in the economy capacity utilization in the range of 82 to 85 is considered tight and can increase the likelihood of price increases or supply shortages in the near term levels below 80 are interpreted as showing slack in the economy which may increase the likelihood of a recession 7the bureau of labor statistics releases employment data in a report called the nonfarm payrolls on the first friday of each month 8 sharp increases in employment indicate prosperous economic growth and potential contractions may be imminent if significant decreases occur these are generalizations however and it is important to consider the current position of the economy the consumer price index cpi also issued by the bls measures the level of retail price changes and the costs that consumers pay and is the benchmark for measuring inflation using a basket that is representative of the goods and services in the economy the cpi compares the price changes month after month and year after year 9 this report is an important economic indicator and its release can increase volatility in equity fixed income and forex markets greater than expected price increases are considered a sign of inflation which will likely cause the underlying currency to depreciate economic systemsfive economic systems illustrate historical practices used to allocate resources to meet the needs of the individual and society in primitive agrarian societies individuals produced necessities from building dwellings growing crops and hunting game at the household or tribal level a political and economic system of europe from the 9th to 15th century feudalism was defined by the lords who held land and leased it to peasants for production who received a promise of safety and security from the lord with the advent of the industrial revolution capitalism emerged and is defined as a system of production where business owners organize resources including tools workers and raw materials to produce goods for market consumption and earn profits supply and demand set prices in markets in a way that can serve the best interests of society socialism is a form of a cooperative production economy economic socialism is a system of production in which there is limited or hybrid private ownership of the means of production prices profits and losses are not the determining factors used to establish who engages in the production what to produce and how to produce it communism holds that all economic activity is centralized through the coordination of state sponsored central planners with common ownership of production and distribution schools of economic theorymany economic theories have evolved as societies and markets have grown and changed however three disciplines of economics neoclassical keynesian and marxian have influenced modern society the principles of neoclassical economics are often used as a framework to illustrate the virtues of capitalism including the tendency of market prices to reach equilibrium as the volume of supply and demand changes the optimal valuation of resources emerges from the forces of individual desire and scarcity john maynard keynes developed the theory of keynesian economics during the great depression arguing against neoclassical theory keynes showed that restrained markets and government intervention in markets create a stable and equitable economic system he advocated for a monetary policy designed to boost demand and investor confidence during economic downturns marxian economics is defined in karl marx s work das kapital marxian economics is a rejection of the classical view of economics arguing against the idea that the free market an economic system determined by supply and demand with little or no government control benefits society he espoused that capitalism only benefits a select few and that the ruling class becomes richer by extracting value out of cheap labor provided by the working class 10 | |
what is a command economy | a command economy is an economy in which production investment prices and incomes are determined centrally by a government a communist society has a command economy | |
what is behavioral economics | behavioral economics combines psychology judgment decision making and economics to understand human behavior branches of economic thought continue to grow and change one such example is the progressive branch of bioeconomics that models economic decisions in terms of managing resources who has influenced the study of economics in the 21st century since 2000 several economists have won the nobel prize in economics including david card for his contributions to labor economics angus deaton for his study of consumption poverty and welfare and paul krugman for his analysis of trade patterns the bottom lineeconomics is a branch of the social sciences focused on the production distribution and consumption of goods and services microeconomics is a type of economics that is concerned with the behavior of individual people and businesses while macroeconomics considers broader trends affecting nations and larger economies in the u s a number of key economic indicators including gdp and cpi are important tools for economists to measure trends and make forecasts | |
what are economies of scale | economies of scale are cost advantages reaped by companies when production becomes efficient companies can achieve economies of scale by increasing production and lowering costs this happens because costs are spread over a larger number of goods costs can be both fixed and variable investopedia mira norianunderstanding economies of scalethe size of the business generally matters when it comes to economies of scale the larger the business the more the cost savings economies of scale can be both internal and external internal economies of scale are based on management decisions while external ones have to do with outside factors internal functions include accounting information technology and marketing which are also considered operational efficiencies and synergies economies of scale are an important concept for any business in any industry and represent the cost savings and competitive advantages larger businesses have over smaller ones most consumers don t understand why a smaller business charges more for a similar product sold by a larger company that s because the cost per unit depends on how much the company produces a company can create a diseconomy of scale when it becomes too large and chases an economy of scale larger companies can produce more by spreading the cost of production over a larger amount of goods an industry may also be able to dictate the cost of a product if several different companies are producing similar goods within that industry there are several reasons why economies of scale give rise to lower per unit costs first specialization of labor and more integrated technology boost production volumes second lower per unit costs can come from bulk orders from suppliers larger advertising buys or lower costs of capital third spreading internal function costs across more units produced and sold helps to reduce costs internal vs external economies of scaleas mentioned above there are two different types of economies of scale internal economies of scale happen when a company cuts costs internally so they re unique to that particular firm this may be the result of the sheer size of a company or because of decisions from the firm s management there are different kinds of internal economies of scale these include larger companies are often able to achieve internal economies of scale lowering their costs and raising their production levels because they can for example buy resources in bulk have a patent or special technology or access more capital external economies of scale on the other hand are achieved because of external factors or factors that affect an entire industry that means no one company controls costs on its own these occur when there is a highly skilled labor pool subsidies and or tax reductions and partnerships and joint ventures anything that can cut down on costs to many companies in a specific industry overcoming limitsmanagement techniques and technology have been focusing on overcoming the limits to economies of scale for decades set up costs are lower due to more flexible technology equipment is priced more closely to match production capacity enabling smaller producers such as steel mini mills and craft brewers to compete more easily outsourcing functional services makes costs more similar across businesses of various sizes these functional services include accounting human resources marketing treasury legal and information technology micro manufacturing hyper local manufacturing and additive manufacturing 3d printing can lower both set up and production costs global trade and logistics have contributed to lower costs regardless of the size of an individual plant according to the international monetary fund the prices of both capital goods and the cost of machinery and equipment have been falling in emerging developed and even industrial countries for the past three decades 1examples of economies of scalejob shops produce products in groups such as shirts with your company logo a significant element of the cost is the setup in job shops larger production runs lower unit costs because the set up costs of designing the logo and creating the silk screen pattern are spread across more shirts in an assembly factory per unit costs are reduced by more seamless technology with robots a restaurant kitchen is often used to illustrate how economies of scale are limited more cooks in a small space get in each other s way in economics charts this has been illustrated with some flavor of a u shaped curve in which the average cost per unit falls and then rises costs rising as production volume grows is termed diseconomies of scale diseconomies of scalediseconomies stem from inefficient managerial or labor policies or over hiring the diseconomies may also be external like a deteriorating transportation network furthermore as a company s scope increases it may have to distribute its goods and services in more dispersed areas this can increase average costs resulting in diseconomies of scale some efficiencies and inefficiencies are location specific if a company has many plants throughout the country they all can benefit from costly inputs such as advertising however efficiencies and inefficiencies can stem from a particular location such as a good or bad climate for farming | |
what are economies of scale | economies of scale are the advantages that can sometimes occur as a result of increasing the size of a business for example a business might enjoy an economy of scale in its bulk purchasing by buying a large number of products at once it could negotiate a lower price per unit than its competitors | |
what causes economies of scale | generally speaking economies of scale can be achieved in two ways first a company can realize internal economies of scale by reorganizing the way their resources such as equipment and personnel are distributed and used within the company second a company can realize external economies of scale by growing in size relative to their competitors using that increased scale to engage in competitive practices such as negotiating discounts for bulk purchases | |
why are economies of scale important | economies of scale are important because they can help provide businesses with a competitive advantage in their industry companies will therefore try to realize economies of scale wherever possible just as investors will try to identify economies of scale when selecting investments | |
when do diseconomies of scale occur | diseconomies of scale can occur when companies fumble their expansion plans they may ramp up production but their costs per unit increase rather than decrease they may have hired too many managers or opened too many locations they may have failed to buy the right equipment or hire the right workers in such cases they may need to reevaluate their expansion plans the bottom lineeconomies of scale can lead to increased success of a business by creating cost advantages when a company becomes more efficient and increases production the per unit cost decreases this cost advantage can result in higher profits or increased sales if the cost advantage is passed on to the consumer through reduced prices | |
what are economies of scope | an economy of scope means that the production of one good reduces the cost of producing another related good economies of scope occur when producing a wider variety of goods or services in tandem is more cost effective for a firm than producing less of a variety or producing each good independently in such a case the long run average and marginal cost of a company organization or economy decreases due to the production of complementary goods and services while economies of scope are characterized by efficiencies formed by variety economies of scale are instead characterized by volume the latter refers to a reduction in marginal cost by producing additional units economies of scale for instance helped drive corporate growth in the 20th century through assembly line production investopedia michela buttignolunderstanding economies of scopeeconomies of scope are economic factors that make the simultaneous manufacturing of different products more cost effective than manufacturing them on their own a simple way to illustrate the contrast is to use the example of a train a single train can carry both passengers and freight more cheaply than having two separate trains one only for passengers and another for freight in this case a single train that has cars dedicated to both categories is far more cost effective and may also result in lower ticket or tonnage costs for the train s users as well economies of scope can occur because the products are co produced by the same process the production processes are complementary or the inputs to production are shared by the products economies of scope can arise from co production relationships between final products in economic terms these goods are called complements in production this occurs when the production of one good automatically produces another good as a byproduct or a kind of side effect of the production process sometimes one product might be a byproduct of another but have value for use by the producer or for sale finding a productive use or market for the co products can reduce both waste and costs and increase revenues for example dairy farmers separate raw milk from cows into whey and curds with the curds going on to become cheese in the process they also end up with a lot of whey which they can then use as a high protein feed for livestock to reduce their overall feed costs or sell as a nutritional product to fitness enthusiasts and weightlifters for additional revenue another example of this is the so called black liquor produced when processing wood into paper pulp instead of being merely a waste product that might be costly to dispose of black liquor can be burned as an energy source to fuel and heat the plant saving money on other fuels or can even be processed into more advanced biofuels for use on site or for sale producing and using the black liquor thus saves costs on producing the paper economies of scope can also result from the direct interaction of two or more production processes companion planting in agriculture is a classic example here such as the three sisters crops historically cultivated by native americans by planting corn pole beans and ground trailing squash together the three sisters method actually increases the yield of each crop while also improving the soil the tall corn stalks provide a structure for the bean vines to climb up the beans fertilize the corn and the squash by fixing nitrogen in the soil and the squash shades out weeds among the crops with its broad leaves all three plants benefit from being produced together so the farmer can grow more crops at lower cost a modern example would be a co operative training program between an aerospace manufacturer and an engineering school where students at the school also work part time or intern at the business the manufacturer can reduce its overall costs by obtaining low cost access to skilled labor and the engineering school can reduce its instructional costs by effectively outsourcing some instructional time to the manufacturer s training managers the final goods being produced airplanes and engineering degrees might not seem to be direct complements or share many inputs but producing them together reduces the cost of both because productive inputs i e land labor and capital usually have more than one use economies of scope can often come from common inputs to the production of two or more different goods for example a restaurant can produce both chicken fingers and french fries at a lower average expense than what it would cost two separate firms to produce each of the goods separately this is because chicken fingers and french fries can share use of the same cold storage fryers and cooks during production proctor gamble is an excellent example of a company that efficiently realizes economies of scope from common inputs since it produces hundreds of hygiene related products from razors to toothpaste the company can afford to hire expensive graphic designers and marketing experts who can use their skills across all of the company s product lines adding value to each one if these team members are salaried each additional product they work on increases the company s economies of scope because of the average cost per unit decreases different ways to achieve economies of scopereal world examples of the economy of scope can be seen in mergers and acquisitions m a newly discovered uses of resource byproducts such as crude petroleum and when two producers agree to share the same factors of production economies of scope are essential for any large business and a firm can go about achieving such scope in a variety of ways first and most common is the idea that efficiency is gained through related diversification products that share the same inputs or that have complementary productive processes offer great opportunities for economies of scope through diversification horizontally merging with or acquiring another company is another a way to achieve economies of scope two regional retail chains for example may merge with each other to combine different product lines and reduce average warehouse costs goods that can share common inputs like this are very suitable for generating economies of scope through horizontal acquisitions example of economies of scopeas one last example assume that company abc is the leading desktop computer producer in the industry company abc wants to increase its product line and remodels its manufacturing building to produce a variety of electronic devices such as laptops tablets and phones since the cost of operating the manufacturing building is spread out across a variety of products the average total cost of production decreases the costs of producing each electronic device in another building would be greater than just using a single manufacturing building to produce multiple products | |
what is an economist | an economist is an expert who studies the relationship between a society s resources and its production or output economists study societies ranging from small local communities to entire nations and even the global economy the expert opinions and research findings of an economist are used to help shape a wide variety of policies including interest rates tax laws employment programs international trade agreements and corporate strategies the duties of an economist are incredibly varied research economic issues conduct surveys and collect data analyze data using mathematical models statistical techniques and software present research results in reports tables and charts interpret and forecast market trends advise businesses governments and individuals on economic topics recommend solutions to economic problems write articles for academic journals and other media according to the bureau of labor statistics the median pay for an economist in 2021 was 105 630 per year or 50 79 per hour 1understanding economiststhere is a good chance that someone interested in a career as an economist will work for the government according to the bureau of labor statistics roughly 36 of all economists work for either a federal or state agency economists are also employed as professors by corporations or as part of economic think tanks 2a career as an economist has two main requirements first economists generally hold advanced degrees such as a ph d or a master s degree the typical entry level education for an economist is a master s degree second economists typically develop an area of specialization where they focus their research efforts economists influence strategic economic plansthe role of an economist includes analyzing data that includes economic indicators such as gross domestic product and consumer confidence surveys economists might research the distribution accessibility and reach of goods and services in order to identify potential trends or make economic forecasts the work of economists might be commissioned to target specific segments or topics where expert assessments are needed this could be done for budgeting and planning purposes when the insights of the economists will serve as the basis for a plan of action for example if there is a change in spending trends in a particular industry investors and companies working in that industry might look to economists to provide perspective on what the next evolution of the market may be furthermore the input of economists can reveal the underlying causes that shape market cycles insights of economists can also be to form forecasts for job market growth as particular segments of the economy grow economists may reference factors and elements that provide a new understanding of what drives trends the assessments that economists provide may draw upon large segments of time and take advantage of large collections of data their theories can also provide a way for others to react to the future direction of the economy companies could use such perspectives to adjust their strategies including whether or not to pursue development on particular products or if a product should be discontinued in favor of a different approach | |
what is an economy | an economy is a complex system of interrelated production consumption and exchange activities which ultimately determine how resources are allocated among participants the production consumption and distribution of goods and services combine to fulfill the needs of those living and operating within the economy an economy can encompass a nation a region a single industry or even just one family investopedia alex dos diazunderstanding economiesan economy encompasses all of the activities related to the production consumption and trade of goods and services in an entity whether the entity is a nation or a small town no two economies are identical each is formed according to its own resources culture laws history and geography each evolves according to the choices and actions of the participants these decisions are made through some combination of market transactions and collective or hierarchical decision making capitalism is characterized by a market based economy communism is characterized by a command based economy types of economiesin the modern world few nations are purely market based or purely command based but most lean toward one or the other of these models market based or free market economies allow people and businesses to freely exchange goods and services according to supply and demand the united states is mostly a market economy producers determine what s sold and produced and what prices to charge if they expect to succeed they will produce what consumers want and charge what consumers are willing to pay through these decisions the laws of supply and demand determine prices and total production if consumer demand for a specific product increases production tends to increase to satisfy the demand the increased demand causes prices to rise until consumers balk and cut back on their purchases demand for the product will then decline and prices will decline with it this constant tug of supply and demand allows a market economy a tendency to naturally balance itself as the prices in one sector rise with demand the money and labor needed to fill that demand shift to those places where they re needed command based economies depend on a central government that controls the production levels pricing and distribution of goods in such a system the government owns industries deemed essential on behalf of the consumers who use them competition among companies is discouraged or banned prices are controlled communism requires a command based economy contemporary examples include cuba and north korea a command based economy attempts to supersede the workings of supply and demand pure market economies rarely exist in the modern world since there s usually some degree of government intervention or central planning even the united states could be considered a mixed economy it may not mandate production but it has ways to influence it for example in truth most of the world s developed economies mix market based and command based models china had a command economy only until 1978 when it began a series of reforms that encouraged private enterprise studying economiesthe study of economies and the factors affecting economies is called economics the discipline of economics can be broken into two major areas of focus microeconomics and macroeconomics microeconomics studies the behavior of individual people and businesses in order to understand why they make the economic decisions they do and how these decisions affect the larger economic system microeconomics studies how a particular value is attached to a product or service it examines how individuals coordinate and cooperate with each other in business microeconomics tends to focus on economic tendencies such as how individual choices and actions impact changes in production clearly principles of psychology and marketing influence microeconomics as the name implies macroeconomics studies the big picture macroeconomics includes the study of economy wide factors such as the effect of rising prices or inflation on the economy it seeks to track and understand the financial indicators that clarify an economy s success or failure over time such as gross domestic product gdp changes in unemployment and consumer spending in short macroeconomics studies how the economy as a whole behaves economic indicatorsas noted above macroeconomics is the study of the big picture and that picture is incomplete without a set of economic indicators these are some of the most closely watched of those indicators gross domestic product gdp is the total value of all of the completed goods and services produced by an economy during a period of one year the gross domestic product of the united states reached 27 94 trillion in 2023 in the u s the bureau of labor statistics bls publishes a monthly unemployment report that breaks down how many people are working the average number of hours they are working and their average earnings this is used to produce the unemployment rate the report estimates the number of people who are working for pay during a given period more importantly the number is tracked over time in order to determine whether unemployment is worsening inflation in consumer prices is measured and tracked so that problems in the economy can be pinpointed if the rate of inflation is outpacing the rate of income growth the economy is in trouble inflation can be negative too this is called deflation but it is relatively rare bls publishes a key inflation metric known as the consumer price index which tracks the costs of goods and services from month to month it breaks down its report into the vital areas of consumer spending such as food energy and rent costs those numbers determine the rate of inflation an economy s balance of trade is a comparison of the amount of money that is spent on imports of goods and services and the amount of money it earns on goods and services it exports it is measured primarily by recording all of the products that pass through the customs office of a country a nation achieves a positive balance of trade when it exports more than it imports it has a negative balance of trade when it buys more than it sells neither is necessarily good or bad a nation may have a negative balance of trade because foreign businesses are heavily investing in its future a nation with a positive balance of trade may have protectionist policies in place that could hurt it in the long run the u s had a balance of trade deficit in 2023 of about 779 8 billion down from 945 3 billion the previous year according to the u s bureau of economic analysis history of the concept of economythe word economy derives from the greek term for household management oikonomia and the word is still used in that context economics as an area of study was touched on by philosophers in ancient greece notably aristotle but the modern study of economics began in 18th century europe particularly in scotland and france the scottish philosopher and economist adam smith who in 1776 wrote a landmark book called the wealth of nations was thought of in his own time as a moral philosopher he and his contemporaries traced the evolution of economies from prehistoric bartering systems to money driven and eventually credit driven economies during the 19th century the development of technology and the growth of international trade created stronger ties among countries a process that accelerated into the great depression and world war ii after 50 years of the cold war the late 20th and early 21st centuries have seen a renewed globalization of economies | |
what is economics | economics is a branch of the sciences that seeks to understand the way a population functions by studying the way its economy functions every group of people develops a survival plan based on shared labor and resources how they do that and how well they succeed at it is central focus of the study of economics | |
what is macroeconomics vs microeconomics | macroeconomics is the study of the overall performance of an economy it evaluates the stability and progress of an economy over time by analysis of key indicators these include gdp employment inflation or deflation and the balance of trade microeconomics is the study of the behavior of the individual consumers and businesses that make up the economy their motivations habits and behaviors are studied to determine whether an economy is functioning in their best interests | |
what is economics in real life | all of us participate in economies we contribute something to the whole by producing or helping to produce a product or offering a service in return we receive money that allows us to buy the goods and services that we can t produce for ourselves the bottom linean economy is system of production and consumption activities that determine the allocation of limited resources every individual within an economy contributes to it in some form in return each expects a share of the goods and services provided by other members of the community | |
what is edtech | edtech a combination of education and technology refers to hardware and software designed to enhance teacher led learning in classrooms and improve students education outcomes edtech is still in the early stages of its development but it shows promise as a method of customizing a curriculum for a student s ability level by introducing and reinforcing new content at a pace the student can handle understanding edtechedtech can be a contentious topic as a large portion of the education system is unionized there are concerns that edtech is an attempt to phase out certain in class duties as a way of reducing costs the creators of edtech emphasize the enhancement potential of the software and technology freeing up the teacher to move into more a facilitator role with time constraints it is difficult for a teacher to teach according to curriculum catch up lower level learners and still keep the top of the class engaged in their work by automating the assessment of ability and adjustment of difficulty edtech can potentially lead to better outcomes for individual students and the class as a whole technology in the classroom experienced two waves of implementation the first was the introduction of hardware into the classroom inevitably the conversation has turned to getting the software to better coordinate and utilize all the hardware these software solutions are edtech many of them are cloud based and pull on educational research to set algorithms for how slowly or rapidly to advance a student along different learning objectives massive online open online courses moocs use technology to reach a vast number of online students around the world while these courses also have issues such as low completion rates they are an attempt to provide education in a way that suits the user edtech concernsmany of the fears about edtech are looking farther into the future where entire courses could potentially be managed by software the current state of the field uses analytics to judge a student s competency in different areas of the curriculum allowing the student to move ahead more quickly in some areas while taking more time to reinforce areas of weakness as each student works through a customized curriculum the teacher acts as a facilitator and trouble shooter with insights provided by the edtech software on a student s strengths and weaknesses in practice edtech is still in the early stages of development for even basic subjects like math or reading and composition skills there are a variety of design challenges for edtech the biggest hurdle is adjusting for different learning styles in the classroom currently edtech is usually delivered through a laptop or tablet resulting in a read and respond learning experience critics have noted that this style can leave other types of learners auditory and kinesthetic for example at a disadvantage as with any new field of technological development edtech will improve the more it is used and the more feedback is collected however edtech faces additional social hurdles students and even more so the parents look to a teacher to create a social environment that enables group learning and other dynamics that aren t currently within the scope of edtech the classroom of the future may depend heavily on edtech to do the heavy lifting of course design but many parents and educators still see value in the group environment separate from the pure academic goals proponents say that like many innovations in education edtech is seeking to improve on the existing model rather than replace it entirely example of a publicly traded edtech companyas of march 2020 k12 inc lrn is one of the biggest players in the edtech space it primarily focuses on providing individualized learning via curriculum software and services to students in kindergarten through grade 12 the company offers full time virtual classrooms single courses and tools and courses to supplement learning | |
what is an education loan | an education loan is a sum of money borrowed to finance post secondary education or higher education related expenses education loans are intended to cover the cost of tuition books and supplies and living expenses while the borrower is in the process of pursuing a degree payments are often deferred while students are in college and depending on the lender for an additional six month period after earning a degree this deferment period is also referred to as a grace period | |
how an education loan works | education loans are issued for the purpose of attending an accredited college or a university to pursue an academic degree education loans can be obtained from the government or through private sector lending sources federal loans often offer lower interest rates and some also offer subsidized interest meaning the united states department of education pays the interest on the loan while a student is in college at least half time 1 private sector loans generally follow more of a traditional lending process for applications with rates that are typically higher than federal government loans types of education loansalthough there are a variety of education loans they can be broken down generally into two basic types federal loans sponsored by the federal government and private loans most borrowers first seek federal government financing if they need to borrow funds for education expenses the first step in seeking education loans through the federal government is to complete a free application for federal student aid fafsa 2 depending on the applicant s status particularly in regard to their parental dependency additional information may be required to complete the application a credit check is not generally required as part of the application process the amount of principal on the loan or loans is primarily based on the cost of attendance at the school the student is planning on attending once a fafsa form is completed the schools listed on the fafsa application work to identify the financial aid package that the student is eligible for 3various types of federal student loans exist including direct subsidized direct unsubsidized and direct consolidation loans if offered and accepted funds will be issued by the federal government to the specified university to cover the student s academic costs if there are remaining funds available they will be disbursed to the student a student may use these funds to cover other expenses that they incur while pursuing a degree if a student qualifies for subsidized loans the borrower s interest will be covered while they are in school if a student qualifies for unsubsidized loans the interest on their loans will be deferred as long as they are enrolled in classes and remain in good academic standing 4in some cases the student loan package that a student is issued through the federal government may suggest that the borrower applies for additional funds through private lenders private student loans also include state affiliated lending nonprofits and institutional loans provided by the schools these types of loans will generally follow a more standard application process like what is typical of any private sector loan applications for private student loans typically require a credit check borrowers can apply directly to individual private sector lenders for funds similar to federal funds the approved amount will be influenced by the school a borrower is attending if approved funds for educational expenses will first be disbursed to the school to cover any pending bills the remaining amount is then sent directly to the borrower special considerationsaccumulated debt from college can be an overwhelming burden after graduation if a student has taken out numerous education loans consolidating them can be a good option for more easily managing the debt load multiple federal education loans can be combined into a single direct consolidation loan 5 also many private lenders now allow borrowers to combine both their federal and private loans into one loan it s important to note that in this scenario the new loan will be a private one because it will be issued by a private lender because the loan will be considered a private loan the debt will no longer be eligible for certain federal programs for loan forgiveness and repayment 6 there is no option for borrowers to combine private and public loans into a new public loan a number of employers are also beginning to integrate consolidation services and student loan payment benefits into their employee benefit programs as a way of helping to increase the support available for managing student loan debt after college students and their families should consider all of their options before signing up for higher education loans that could become a crushing burden in the future some alternatives to or ways to reduce the size of loans include working part time accepting work study offers attending a less expensive school finding a job that offers tuition reimbursement as a benefit and applying for scholarships that help to cover the cost of tuition and room and board when the student has graduated it also helps to search for a job that offers help with student debt as a benefit sometimes you may have more funds from student loans than you need to pay for your education perhaps a relative gifted money to your college account or you received a scholarship that you hadn t planned to receive it s tempting to use excess student loan funds for well fun but the ethical and financially sound approach is to apply the funds back to your debt also in the case of government subsidized loans you could face legal action if you misuse the funds | |
what type of debt are student loans | student loans are considered unsecured installment debts meaning there isn t a physical asset tied to them and they re paid back in a set number of installments over an agreed upon period of time 7 | |
what are the four major types of educational loans | there are four types of federal student loans available as part of the william d ford federal direct loan program 89 | |
what are three effective techniques for managing student loan debt | there are several ways to better manage student debt three particularly useful strategies include paying off loans with the highest interest rates first paying down extra principal whenever possible and exploring operations for debt forgiveness | |
what is an education ira | an education ira is a tax advantaged investment account for higher education now more formally known as a coverdell education savings account esa under this educational savings vehicle parents and guardians are allowed to make nondeductible contributions to an education individual retirement account ira for a child under the age of 18 1understanding education irasfunds saved under an education ira are meant to be used to cover future educational expenses such as tuition books and uniforms at the elementary secondary and higher education levels 2 the funds in an education ira can be withdrawn tax free when they are needed for educational purposes 1education iras are also referred to as coverdell accounts or simply as an esa despite their ira moniker they are for educational expenses not retirement savings though they work in a similar way education iras existed before they were renamed coverdell esas in 2002 and were made even more attractive as an educational savings vehicle when the list of qualified expenses was extended to certain k 12 expenses they work in a way similar to roth iras in that both allow annual nondeductible contributions to a specially designated investment account that investment grows free of federal taxes and withdrawals are tax free as well as long as certain requirements are met related to the year s contributions are made and the year s withdrawals are made 2special considerationseducation iras have many conditions and stipulations such as 1educational iras vs 529 plansboth the educational ira and the 529 plan allow plan holders to set up an account for a beneficiary of their choice the tax treatment of education iras is similar to that of 529 savings plans though with a few notable differences they are similar in that both allow for tax deferred growth and for those proceeds to be withdrawn tax free for qualified educational expenses at a qualified educational institution education iras are covered under title 26 subtitle a chapter 1 subchapter f part viii subsection 530 of the u s code 3there is no limit to how many 529 plans a plan holder can set up 2 contributions though are limited to the cost of education as outlined by the state where the accounts are held although accounts are set up for beneficiaries they cannot lay claim to the funds these plans can cover a number of different things the tax cuts and jobs act tcja of 2017 made changes to the rules involving 529 plans 4 plan holders can use up to a maximum of 10 000 to pay for k 12 tuition from public private or religious institutions per beneficiary each year penalty and tax free additional changes expanded the rules for 529 plans when the setting every community up for retirement enhancement act secure was signed into law in december 2019 5 the owner of the account can withdraw up to 10 000 to use toward the payment of tuition and other related expenses for a beneficiary s registered apprenticeship programs another change includes the ability for plan holders to withdraw a lifetime maximum of 10 000 to pay down a beneficiary s qualified student debt | |
what is an effective annual interest rate | an effective annual interest rate is the real return on a savings account or any interest paying investment when the effects of compounding over time are taken into account it also reflects the real percentage rate owed in interest on a loan a credit card or any other debt it is also called the effective interest rate the effective rate or the annual equivalent rate aer theresa chiechi investopediaunderstanding the effective annual interest ratethe effective annual interest rate describes the true interest rate associated with an investment or loan the most important feature of the effective annual interest rate is that it takes into account the fact that more frequent compounding periods will lead to a higher effective interest rate 1suppose for instance you have two loans each with a stated interest rate of 10 in which one compounds annually and the other twice yearly even though they both have a stated interest rate of 10 the effective annual interest rate of the loan that compounds twice per year will be higher effective annual interest rate formulathe following formula is used to calculate the effective annual interest rate 1effective annual interest rate 1 in n 1where i nominal interest raten number of periods begin aligned effective annual interest rate left 1 frac i n right n 1 textbf where i text nominal interest rate n text number of periods end aligned effective annual interest rate 1 ni n 1where i nominal interest raten number of periods | |
what the effective annual interest rate tells you | a certificate of deposit cd a savings account or a loan offer may be advertised with its nominal interest rate and effective annual interest rate the nominal interest rate does not reflect the effects of compounding interest or even the fees that come with these financial products the effective annual interest rate is the real return or interest payment that s why the effective annual interest rate is an important financial concept to understand you can compare various offers accurately only if you know their effective annual interest rates example of effective annual interest rateconsider these two offers investment a pays 10 interest compounded monthly investment b pays 10 1 compounded semiannually which is the better offer in both cases the advertised interest rate is the nominal interest rate the effective annual interest rate is calculated by adjusting the nominal interest rate for the number of compounding periods that the financial product will undergo in this case that period is one year the formula and calculations are as follows investment b has a higher stated nominal interest rate but the effective annual interest rate is lower than the effective rate for investment a this is because investment b compounds fewer times over the course of the year if an investor were to put 5 million into one of these investments the wrong decision would cost more than 5 800 per year the effective annual interest rate is important because borrowers might underestimate the true cost of a loan without it and investors need it to project the actual expected return on an investment such as a corporate bond effect of the number of compounding periodsas the number of compounding periods increases so does the effective annual interest rate quarterly compounding produces higher returns than semiannual compounding monthly compounding produces higher returns than quarterly and daily compounding produces higher returns than monthly below is a breakdown of the results of these different compound periods with a 10 nominal interest rate there is a ceiling to the compounding phenomenon even if compounding occurs an infinite number of times not just every second or microsecond but continuously the limit of compounding is reached with 10 the continuously compounded effective annual interest rate is 10 517 the continuous rate is calculated by raising the number e approximately equal to 2 71828 to the power of the interest rate and subtracting one in this example it would be 2 71828 0 1 1 effective annual interest rate vs nominal interest ratethe primary difference between an effective annual interest rate and a nominal interest rate is the compounding periods the nominal interest rate is the stated interest rate that does not take into account the effects of compounding interest or inflation for this reason it s sometimes also called the quoted or advertised interest rate on the other hand the ear considers the effects of compounding interest it represents the true annual interest rate after accounting for the impact of compounding interest and it is typically higher than the nominal interest rate in this context the ear may be used as opposed to the nominal rate when communicating rates in an attempt to lure business for example if a bank offers a nominal interest rate of 5 per year on a savings account and compounds interest monthly the effective annual interest rate will be higher than 5 therefore the bank might consider promoting the account at the ear because that rate will appear higher understand the psychological marketing approach of communicating effective annual interest rates for industries that want to boast higher rates ear is best for industries that want to downplay costs nominal rates are best uses of effective annual interest rateseffective annual interest rates are used in various financial calculations and transactions this includes but isn t necessarily limited to the following types of analysis limitations on effective annual interest ratesthough broadly used across the financial sector ear has several downsides the ear calculation assumes that the interest rate will be constant throughout the entire period i e the full year and that there are no fluctuations in rates however in reality interest rates can change frequently and rapidly often impacting the overall rate of return most ear calculations also do not consider the impact of transaction service or account maintenance fees these can also affect the total return ear calculations usually do not consider the impact of taxes on the returns taxes can significantly reduce the actual returns on investments or savings and it s important to factor them into any analysis though a given individual may truly earn at the ear their true return may be reduced by 20 or higher based on what individual tax bracket they reside in ear quotes are often unsuitable for short term investments because there are fewer compounding periods more often ear is used for long term investments as the impact of compounding may be significant this approach may limit the vehicles in which ear is calculated or communicated lastly as the ear calculation is a single rate it does not calculate communicate or convey any risk associated with the investment or loan higher returns often come with higher risk and it s important to consider the risk associated with an investment or loan before deciding just because a vehicle has a higher ear does not necessarily make it the ideal opportunity for every individual considering varying investment preferences or risk tolerances | |
how do you calculate the effective annual interest rate | the effective annual interest rate is calculated using the following formula effective annual interest rate 1 in n 1where i nominal interest raten number of periods begin aligned effective annual interest rate left 1 frac i n right n 1 textbf where i text nominal interest rate n text number of periods end aligned effective annual interest rate 1 ni n 1where i nominal interest raten number of periods although it can be done by hand most investors will use a financial calculator spreadsheet or online program moreover investment websites and other financial resources regularly publish the effective annual interest rate of a loan or investment this figure is also often included in the prospectus and marketing documents prepared by the security issuers | |
what is the purpose of effective annual interest rates | the purpose of the effective annual interest rate is to make interest rates comparable regardless of their compounding periods investors savers or borrowers can take nominal rates with different compounding periods e g one that compounds weekly one that compounds monthly to see which will be most beneficial to them | |
what is a nominal interest rate | a nominal interest rate does not consider any fees or compounding of interest it is often the rate stated by financial institutions | |
is it better to have a higher ear | it is better for savers investors to have a higher ear though it is worse for borrowers to have a higher ear in either situation the ear will likely be higher than the nominal rate it may be more strategic to understand how the ear has changed in recent history and what future trends look like when evaluating future transactions the bottom linebanks and other financial institutions typically advertise their money market rates using the nominal interest rate which does not consider fees or compounding the effective annual interest rate does take compounding into account and results in a higher rate than the nominal the more compounding periods there are the higher the ultimate effective interest rate the higher the effective annual interest rate is the better it is for savers investors but worse for borrowers when comparing interest rates on a deposit or a loan consumers should pay attention to the effective annual interest rate not the headline grabbing nominal interest rate | |
what is effective date | in contract law the effective date is the date that an agreement or transaction between or among signatories becomes binding for an initial public offering ipo it is the date when shares can first be traded on an exchange both parties to a contract usually need to agree on an effective date before a contract is signed understanding effective datesbusiness agreements and transactions are documented with effective dates which are the times when parties to the contract begin their obligations to perform under the contract these contracts can be in the form of employment agreements credit or loan agreements or commercial transaction deals as far as the effective date is concerned the parties will decide whether the contract should officially begin on the date of signing on a date that has already passed backdating or on a future date for a company that wants to go public the effective date occurs within 30 days after the security is registered with the securities and exchange commission sec giving time for the sec to review the form s 1 registration for completeness of disclosure so that prospective investors can make informed decisions during this review period the sec can ask questions request clarifications or instruct the company to fill or amend certain sections of the filing examples of effective datesthe ipo process is tightly controlled by the sec twilio inc filed for an ipo on may 26 2016 shortly after the company submitted an amended filing taking care to print on the cover page of the prospectus the following the effective date turned out to be june 23 2016 twilio s shares began trading that day on websites effective dates are often found in the terms and conditions and privacy policies unless a company makes a special effort to create an individual agreement with a very specialized end user or group of end users terms and conditions or terms of use and a privacy policy will apply to all users of a given website or internet platform users are usually required to accept the terms and conditions when they download an associated app or log on to a website those terms should not be different from terms given to and read by any other use at any other time unless those terms are updated and all users are asked to approve the revised terms in such situations the effective date for terms and conditions and privacy policy agreements is not when the user agrees to it but when the terms were last updated for these types of agreements these dates are not indicated by effective date but last revision or last updated | |
what is effective duration | effective duration is a duration calculation for bonds that have embedded options this measure of duration takes into account the fact that expected cash flows will fluctuate as interest rates change and is therefore a measure of risk effective duration can be estimated using modified duration if a bond with embedded options behaves like an option free bond understanding effective durationa bond that has an embedded feature increases the doubtfulness of cash flows thus making it hard for an investor to determine the rate of return of a bond the effective duration helps calculate the volatility of interest rates in relation to the yield curve and therefore the expected cash flows from the bond effective duration calculates the expected price decline of a bond when interest rates rise by 1 the value of the effective duration will always be lower than the maturity of the bond a bond with embedded options behaves like an option free bond when exercising the embedded option would offer the investor no benefit as such the security s cash flows cannot be expected to change given a change in yield for example if existing interest rates were 10 and a callable bond was paying a coupon of 6 the callable bond would behave like an option free bond because it would not be optimal for the company to call the bond and re issue it at a higher interest rate the longer the maturity of a bond the larger its effective duration effective duration calculationthe formula for effective duration contains four variables they are p 0 the bond s original price per 100 worth of par value p 1 the price of the bond if the yield were to decrease by y percent p 2 the price of the bond if the yield were to increase by y percent y the estimated change in yield used to calculate p 1 and p 2 the complete formula for effective duration is effective duration p 1 p 2 2 x p 0 x y example of effective durationas an example assume that an investor purchases a bond for 100 par and that the bond is currently yielding 6 using a 10 basis point change in yield 0 1 it is calculated that with a yield decrease of that amount the bond is priced at 101 it is also found that by increasing the yield by 10 basis points the bond s price is expected to be 99 25 given this information the effective duration would be calculated as effective duration 101 99 25 2 x 100 x 0 001 1 75 0 20 8 75the effective duration of 8 75 means that if there were to be a change in yield of 100 basis points or 1 then the bond s price would be expected to change by 8 75 this is an approximation the estimate can be made more accurate by factoring in the bond s effective convexity | |
what is effective gross income | effective gross income egi is the potential gross rental income plus other income minus vacancy and credit costs of a rental property egi can be calculated by taking the potential gross income from an investment property add other forms of income generated by that property and subtract vacancy and collection losses understanding effective gross income egi egi is a key variable in determining the value of a rental property and the true positive cash flow that property could generate rental cash flow is not a simple calculation but includes all forms of income generated by the property minus the realistic costs involved with rental income if we look at the variables of the egi formula we can see how rental income plays out in the real world egi formula explainedgross potential rental income is the hypothetical amount an investor would receive without any of the rental headwinds that are commonplace in the real world it assumes that your rental property will be rented every day of the year and that renters will pay the agreed to rent documented in the lease for example if the agreed to rent is 2 000 a month the gross potential rental income is 24 000 | |
what constitutes other income generated from rental properties here are some of the most common sources of cash flow not derived directly from rental payments | in real life a unit will not always be rented for the entire year vacancy costs are the periods between tenants where the owner is not receiving rent because there is a vacancy vacancy costs are forecasts of how long the owner believes his unit will be without a tenant if the owner has managed investment properties for some time this cost may be estimated based upon his her managerial experience or industry data credit costs will occur when a rental unit is occupied and the owner does not receive the agreed upon rental payment the renter has not paid the rent or has not paid it in its entirety as with vacancy costs this amount will be an estimate that may be based on historical data | |
why egi is important | egi is essential to the real estate investor because at the end of the day they need to know that the property they are considering purchasing generates enough positive cash flow to cover monthly operating expenses as well as any liens or encumbrances they may have taken on to purchase the property | |
what is the effective tax rate | the term effective tax rate refers to the percent of income that an individual or corporation owes pays in taxes the effective tax rate for individuals is the average rate at which their earned income such as wages and unearned income such as stock dividends are taxed the effective tax rate for a corporation is the average rate at which its pre tax profits are taxed while the statutory tax rate is the legal percentage established by law investopedia laura porter | |
how to calculate the effective tax rate | the effective tax rates for individuals and corporations look like this when they re expressed as formulas so if you want to calculate your effective tax rate here s how you do it | |
how the effective tax rate works | as noted above the effective tax rate is the average tax rate of a taxpaying entity this includes both individual taxpayers and corporations the effective tax rate is expressed as a percentage the effective tax rate typically refers only to federal income taxes and doesn t take into account any other types of taxes including to determine their overall effective tax rate individuals can add up their total tax burden and divide that by their taxable income this calculation can be useful when trying to compare the effective tax rates of two or more individuals or what a particular individual might pay in taxes if they lived in a high tax vs a low tax state a consideration for many people thinking about relocating in retirement investors may use effective tax rate as a profitability indicator for a company but it can be difficult to determine the reason for year to year fluctuations in the etr effective tax rate vs marginal tax ratethe effective tax rate is a more accurate representation of a person s or corporation s overall tax liability than their marginal tax rate and it is typically lower when considering a marginal versus an effective tax rate bear in mind that the marginal tax rate refers to the highest tax bracket into which their income falls in a graduated or progressive income tax system like the one in the united states income is taxed at differing rates that rise as income hits certain thresholds two individuals or companies with income in the same upper marginal tax bracket may end up with very different effective tax rates depending on how much of their income was in the top bracket federal tax bracketsfederal tax brackets are determined and passed into law these brackets are overseen in the u s by the internal revenue service irs the amount of income and tax filing status determines the tax brackets in which individual taxpayers fall the table below highlights the current tax brackets in the united states example of an effective tax rateimagine for example a graduated tax system where income under 100 000 is taxed at 10 income between 100 000 and 300 000 is taxed at 15 and income over 300 000 is taxed at 25 now consider two individuals who both hit the upper tax bracket of 25 although one had a taxable income of 500 000 while the other had a taxable income of 360 000 both individuals would pay 10 on their first 100 000 of income or 10 000 both would then pay 15 percent on their income between 100 000 and 300 000 or 30 000 15 of 200 000 finally both would also pay 25 on their earnings over the 300 000 threshold for the individual with 360 000 in taxable income that would come to 15 000 25 of 60 000 but for the individual with 500 000 in taxable income the tax would be 50 000 25 of 200 000 their total tax obligations would be 55 000 and 90 000 respectively while both individuals could say they re in the 25 bracket the one with the higher income has an effective tax rate of 18 90 000 in tax divided by 500 000 in income while the other s effective tax rate is 15 3 55 000 divided by 360 000 | |
how do i calculate my effective tax rate | you can easily calculate your effective tax rate as an individual taxpayer do this by dividing your total tax by your taxable income to get the rate multiply by 100 you can find your total tax on line 24 of form 1040 and your taxable income on line 15 of the form | |
what s the difference between the effective and marginal tax rate | an effective tax rate is the average tax rate for an individual or corporate taxpayer as such it s the percentage of taxes owed from the taxpayer s annual income a marginal tax rate on the other hand is the total amount of tax levied on different levels of income this means that a taxpayer s tax rate gets higher as their income rises taxpayers are divided into tax brackets under marginal tax systems where the first level of income is charged a lower rate any income earned above that incurs a higher rate | |
which is lower the effective tax rate or the marginal tax rate | an individual s effective tax rate is lower than the marginal rate that s because the marginal tax rate breaks up your income into different levels the first level of income incurs a lower tax rate while higher levels of income are taxed at the highest rate any amounts that fall in between are charged taxes based on levels in between the bottom lineyour effective tax rate is the percentage of tax you owe on your taxable income this is based on brackets set and maintained by the irs you can easily figure out your effective tax rate by dividing the total tax by your taxable income from form 1040 for corporations the effective tax rate is calculated by dividing the total tax by earnings before interest if you re unsure about anything related to your taxes make sure you consult a tax advisor or professional who can guide you in the right direction correction nov 3 2022 a previous version of this article misstated that taxpayers can calculate their effective tax rate by dividing the figure found on line 16 of form 1040 by the figure found on line 11b on form 1040 the correct way to calculate your effective tax rate is by dividing the figure from line 24 or your total tax by the figure from line 15 which is your taxable income then multiplying that figure by 100 | |
what is the effective yield | the effective yield is the return on a bond that has its interest payments or coupons reinvested at the same rate by the bondholder effective yield is the total yield an investor receives in contrast to the nominal yield which is the stated interest rate of the bond s coupon effective yield takes into account the power of compounding on investment returns while nominal yield does not understanding effective yieldthe effective yield is a measure of the coupon rate which is the interest rate stated on a bond and expressed as a percentage of the face value coupon payments on a bond are typically paid semi annually by the issuer to the bond investor this means that the investor will receive two coupon payments per year effective yield is calculated by dividing the coupon payments by the current market value of the bond effective yield is one way that bondholders can measure their yields on bonds there s also the current yield which represents a bond s annual return based on its annual coupon payments and current price as opposed to the face value though similar current yield doesn t assume coupon reinvestment as effective yield does the drawback of using the effective yield is that it assumes that coupon payments can be reinvested in another vehicle paying the same interest rate this also means that it assumes the bonds are selling at par this is not always possible considering the fact that interest rates change periodically falling and rising due to certain factors in the economy effective yield vs yield to maturity ytm the yield to maturity ytm is the rate of return earned on a bond that is held until maturity to compare the effective yield to the yield to maturity ytm convert the ytm to an effective annual yield if the ytm is greater than the bond s effective yield then the bond is trading at a discount to par on the other hand if the ytm is less than the effective yield the bond is selling at a premium ytm is what s called a bond equivalent yield bey investors can find a more precise annual yield once they know the bey for a bond if they account for the time value of money in the calculation this is known as an effective annual yield eay example of effective yieldif an investor holds a bond with a face value of 1 000 and a 5 coupon paid semi annually in march and september he will receive 5 2 x 1 000 25 twice a year for a total of 50 in coupon payments however the effective yield is a measure of return on a bond assuming the coupon payments are reinvested if payments are reinvested then his effective yield will be greater than the current yield or nominal yield due to the effect of compounding reinvesting the coupon will produce a higher yield because interest is earned on the interest payments the investor in the example above will receive a little more than 50 annually using the effective yield evaluation the formula for calculating effective yield is as follows | |
where | following our initial example presented above the investor s effective yield on his 5 coupon bond will be note that since the bond pays interest semi annually payments will be made twice to the bondholder per year hence the number of payments per year is two from the calculation above the effective yield of 5 06 is clearly higher than the coupon rate of 5 since compounding is taken into consideration to understand this another way let s scrutinize the details of the coupon payment in march the investor receives 2 5 x 1 000 25 in september due to interest compounding he will receive 2 5 x 1 000 2 5 x 25 2 5 x 1 025 25 625 this translates to an annual payment of 25 in march 25 625 in september 50 625 the real interest rate is therefore 50 625 1 000 5 06 | |
what is efficiency | the term efficiency refers to the peak level of performance that uses the least amount of inputs to achieve the highest amount of output efficiency requires reducing the number of unnecessary resources used to produce a given output including personal time and energy efficiency is a measurable concept that can be determined using the ratio of useful output to total input increased efficiency minimizes the waste of resources such as physical materials energy and time while accomplishing the desired output investopedia yurle villegasunderstanding efficiencythe term efficiency can be defined as the ability to achieve an end goal with little to no waste effort or energy being efficient means you can achieve your results by putting the resources you have in the best way possible put simply something is efficient if nothing is wasted and all processes are optimized this includes the use of money human capital production equipment and energy sources efficiency can be used in a variety of ways to describe various optimization processes as such analyzing efficiency can help reduce costs and increase bottom lines for instance as noted above efficiency is measurable and can be expressed as a ratio or percentage you can measure it by using the following formula output or work output is the total amount of useful work completed without accounting for any waste and spoilage if you want to express efficiency as a percentage simply by multiplying the ratio by 100 efficiency measures any performance that uses minimal inputs to get the maximum number of outputs put simply you re efficient if you get more by using less types of efficiencyefficiencies can be divided into many different categories we ve outlined some of the key types below including economic efficiency market efficiency and operational efficiency economic efficiency refers to the optimization of resources to best serve each person in that economic state no set threshold determines the effectiveness of an economy but indicators include goods brought to market at the lowest possible cost and labor that provides the greatest possible output market efficiency describes how well prices integrate available information this means that markets are efficient when all information is already incorporated into prices there is no way to beat the market since there are no undervalued or overvalued securities available market efficiency was formalized in 1970 by economist eugene fama whose efficient market hypothesis emh states that an investor can t outperform the market fama also stated that market anomalies should not exist because they will immediately be arbitraged away operational efficiency measures how well profits are earned as a function of operating costs the greater the operational efficiency the more profitable the firm or investment this is because the entity is able to generate greater income or returns for the same or lower cost than an alternative in financial markets operational efficiency occurs when transaction costs and fees are reduced a historical lookbreakthroughs in economic efficiency often coincide with the invention of new tools that complemented labor including we also saw the emergence of efficiencies in time consider the factory system in which each participant focuses on one task in a factory line this system increased operational output while saving time many scientists developed practices to optimize specific task performance one famous example is the novel cheaper by the dozen by frank bunker gilbreth jr and ernestine gilbreth carey in the book gilbreth jr develops systems to maximize efficiency in even the most mundane tasks such as brushing your teeth the impacts of efficiencyefficiency is an important attribute because all inputs are scarce time money and raw materials are limited and it is important to conserve them while maintaining an acceptable level of output an efficient society is better able to serve its citizens and function competitively goods that are produced efficiently are sold at a lower price advances as a result of efficiency have facilitated higher standards of living such as supplying homes with electricity running water and giving people the ability to travel efficiency reduces hunger and malnutrition because goods are transported farther and quicker advances in efficiency also allow greater productivity in a shorter amount of time example of efficiencyindustry 4 0 is the fourth industrial revolution characterized by digitalization factory processes manufacturing and service industries are all more efficient thanks to more powerful computers cloud computing the industrial internet of things iot data analytics robotics artificial intelligence and machine learning for example data analytics can be applied in an industrial setting to inform factory or plant managers when machinery needs maintenance or replacement this predictive maintenance can substantially reduce operational costs | |
how do you calculate efficiency | efficiency can be expressed as a ratio by using the following formula output input output or work output is the total amount of useful work completed without accounting for any waste and spoilage you can also express efficiency as a percentage by multiplying the ratio by 100 | |
what is allocative efficiency | allocative efficiency occurs in an efficient market this is where capital is allocated in the best way possible to benefit each party involved it allows for the even distribution of goods and services financial services and other key elements to consumers businesses and other entities so they can be used in the best way possible allocative efficiency which is also referred to as allocated efficiency facilitates decision making and economic growth | |
what is peak efficiency | peak energy is the highest level of efficiency you can reach this kind of efficiency occurs when all capital resources and individual participants are properly allocated and fully functional to the best of their ability for instance peak economic efficiency occurs when the economy is productive and the standard of living for citizens is high | |
what is energy efficiency | energy efficiency occurs when you use less energy to achieve the same result being energy efficient reduces energy waste and greenhouse gases as well energy demand it also helps cut down on bills and overall costs using new and more efficient ways to consume energy for example consumers can purchase energy efficient appliances to cut down on their energy bills while corporations may swap out older production equipment with new more efficient ones to increase output while cutting down on production costs | |
what is a measure of efficiency in an investments | an investment s measure of efficiency is its return on investment this is the way investors and financial professionals measure how efficiently an investment makes a profit this metric can also be used to compare one investment to another or multiple investments in a particular class such as mutual funds that invest in the same asset class roi can be expressed as a ratio by dividing an investment s return by its cost it can also be expressed as a percentage by multiplying the result by 100 the bottom line | |
when you re efficient it means that you re able to achieve your goals with as little money and effort as possible without producing too much waste essentially you use very little to get the biggest result possible | efficiency is important for businesses and individuals alike businesses that run efficiently can reduce their costs and improve their bottom lines similarly consumers who make choices to become more efficient such as choosing energy efficient appliances or investments that have the best possible returns while serving their investment needs end up saving money and making more in the long run if you need proof just use the formula noted above and use it as a guideline to help you make some important decisions about your financial health | |
what is the efficiency ratio | the efficiency ratio is typically used to analyze how well a company uses its assets and liabilities internally an efficiency ratio can calculate the turnover of receivables the repayment of liabilities the quantity and usage of equity and the general use of inventory and machinery this ratio can also be used to track and analyze the performance of commercial and investment banks | |
what does the efficiency ratio tell you | efficiency ratios also known as activity ratios are used by analysts to measure the performance of a company s short term or current performance all of these ratios use numbers in a company s current assets or current liabilities quantifying the operations of the business an efficiency ratio measures a company s ability to use its assets to generate income for example an efficiency ratio often looks at various aspects of the company such as the time it takes to collect cash from customers or to convert inventory to cash this makes efficiency ratios important because an improvement in the efficiency ratios usually translates to improved profitability these ratios can be compared with peers in the same industry and can identify businesses that are better managed relative to the others some common efficiency ratios are accounts receivable turnover fixed asset turnover sales to inventory sales to net working capital accounts payable to sales and stock turnover ratio efficiency ratios for banksin the banking industry an efficiency ratio has a specific meaning for banks the efficiency ratio is non interest expenses revenue this shows how well the bank s managers control their overhead or back office expenses like the efficiency ratios above this allows analysts to assess the performance of commercial and investment banks efficiency ratio expenses revenue not including interest begin aligned text efficiency ratio frac text expenses dagger text revenue dagger text not including interest end aligned efficiency ratio revenueexpenses not including interest since a bank s operating expenses are in the numerator and its revenue is in the denominator a lower efficiency ratio means that a bank is operating better an efficiency ratio of 50 or under is considered optimal if the efficiency ratio increases it means a bank s expenses are increasing or its revenues are decreasing for example bank x reported quarterly earnings and had an efficiency ratio of 57 1 which was lower than the 63 2 ratio it reported for the same quarter last year this means the company s operations became more efficient increasing its assets by 80 million for the quarter | |
what does an efficiency ratio measure | an efficiency ratio measures a company s ability to use its assets to generate income it often looks at various aspects of the company such as the time it takes to collect cash from customers or to convert inventory to cash an improvement in efficiency ratio usually translates to improved profitability | |
what does the efficiency ratio mean in banking | an efficiency ratio has a specific meaning for banks it is referred to as non interest expenses revenue and shows how well bank managers control their overhead or back office expenses | |
how do analysts use efficiency ratios | analysts use efficiency ratios to measure the performance of a business s short term or current performance all of these ratios use numbers in a firm s current assets or current liabilities quantifying the operations of the business the bottom linethe efficiency ratio typically analyzes how well a company uses its assets and liabilities internally it can calculate the turnover of receivables the repayment of liabilities the quantity and usage of equity and the general use of inventory and machinery it can also be used to track and analyze the performance of commercial and investment banks | |
what is the efficient frontier | the efficient frontier is the set of optimal portfolios that offer the highest expected return for a defined level of risk or the lowest risk for a given level of expected return portfolios that lie below the efficient frontier are sub optimal because they do not provide enough return for the level of risk portfolios that cluster to the right of the efficient frontier are sub optimal because they have a higher level of risk for the defined rate of return understanding the efficient frontierthe efficient frontier theory was introduced by nobel laureate harry markowitz in 1952 and is a cornerstone of modern portfolio theory mpt the efficient frontier rates portfolios investments on a scale of return y axis versus risk x axis 12 the compound annual growth rate cagr of an investment is commonly used as the return component while standard deviation annualized depicts the risk metric the efficient frontier graphically represents portfolios that maximize returns for the risk assumed returns are dependent on the investment combinations that make up the portfolio a security s standard deviation is synonymous with risk ideally an investor seeks to fill a portfolio with securities offering exceptional returns but with a combined standard deviation that is lower than the standard deviations of the individual securities 3the less synchronized the securities lower covariance the lower the standard deviation if this mix of optimizing the return versus risk paradigm is successful then that portfolio should line up along the efficient frontier line a key finding of the concept was the benefit of diversification resulting from the curvature of the efficient frontier the curvature is integral in revealing how diversification improves the portfolio s risk reward profile it also reveals that there is a diminishing marginal return to risk adding more risk to a portfolio does not gain an equal amount of return optimal portfolios that comprise the efficient frontier tend to have a higher degree of diversification than the sub optimal ones which are typically less diversified criticisms of the efficient frontierthe efficient frontier and modern portfolio theory have many assumptions that may not properly represent reality for example one of the assumptions is that asset returns follow a normal distribution 4in reality securities may experience returns also known as tail risk that are more than three standard deviations away from the mean consequently asset returns are said to follow a leptokurtic distribution or heavy tailed distribution additionally markowitz posits several assumptions in his theory such as that investors are rational and avoid risk when possible that there are not enough investors to influence market prices and that investors have unlimited access to borrowing and lending money at the risk free interest rate 4however reality proves that the market includes irrational and risk seeking investors there are large market participants who could influence market prices and there are investors who do not have unlimited access to borrowing and lending money special considerationsone assumption in investing is that a higher degree of risk means a higher potential return conversely investors who take on a low degree of risk have a low potential return according to markowitz s theory there is an optimal portfolio that could be designed with a perfect balance between risk and return the optimal portfolio does not simply include securities with the highest potential returns or low risk securities the optimal portfolio aims to balance securities with the greatest potential returns with an acceptable degree of risk or securities with the lowest degree of risk for a given level of potential return the points on the plot of risk versus expected returns where optimal portfolios lie are known as the efficient frontier assume a risk seeking investor uses the efficient frontier to select investments the investor would select securities that lie on the right end of the efficient frontier the right end of the efficient frontier includes securities that are expected to have a high degree of risk coupled with high potential returns which is suitable for highly risk tolerant investors conversely securities that lie on the left end of the efficient frontier would be suitable for risk averse investors | |
why is the efficient frontier important | the curvature of the efficient frontier graphically shows the benefit of diversification and how this can improve a portfolio s risk versus reward profile | |
what is the optimal portfolio | an optimal portfolio is one designed with a perfect balance of risk and return the optimal portfolio looks to balance securities that offer the greatest possible returns with acceptable risk or the securities with the lowest risk given a certain return |
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