Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Private Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate elementary and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating individual wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do step by step climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will strike the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a excellent deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to accomplish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to begin saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Three,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of comeback (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Trio,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this clean sum is the result of saving $Trio,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but reminisce that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a flawlessly achievable objective for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween ordinary and compound interest, and the power of compound interest.

Elementary and Compound Interest

Ordinary interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for ordinary interest:

Principal × Rate × Time = Interest

Step Two. Practice using the plain interest formula.

Example 1: $100 Deposit at a ordinary interest rate of 5% held for one year is:

Plain interest in this example is $Five.

Example Two: $100 Deposit at a ordinary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Elementary interest in this example is $Five.

Step Three. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two plain interest formulas together.

Total future amount (with elementary interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the plain interest formula to our three year example.

Total future amount (with plain interest) = $100 + ($100 × 0.05 × Three) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year script. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with ordinary interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a fat difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Excellent Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is enormously difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: accomplish significant extra education and training after graduating from high school and commence saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a ordinary interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Three) = $Five,900

If your receive $500 in plain interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Individual Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate plain and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating individual wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do little by little climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will strike the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a excellent deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to accomplish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to embark saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Trio,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of come back (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Three,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this neat sum is the result of saving $Trio,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but recall that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a ideally achievable purpose for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween ordinary and compound interest, and the power of compound interest.

Plain and Compound Interest

Plain interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for elementary interest:

Principal × Rate × Time = Interest

Step Two. Practice using the ordinary interest formula.

Example 1: $100 Deposit at a ordinary interest rate of 5% held for one year is:

Elementary interest in this example is $Five.

Example Two: $100 Deposit at a elementary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Elementary interest in this example is $Five.

Step Three. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two ordinary interest formulas together.

Total future amount (with elementary interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the plain interest formula to our three year example.

Total future amount (with ordinary interest) = $100 + ($100 × 0.05 × Trio) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year script. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with elementary interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a large difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Good Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is utterly difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: finish significant extra education and training after graduating from high school and begin saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a plain interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Trio) = $Five,900

If your receive $500 in plain interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Individual Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate plain and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating individual wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do little by little climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will hit the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a fine deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to accomplish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to commence saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Three,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of come back (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Trio,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this neat sum is the result of saving $Three,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but reminisce that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a ideally achievable aim for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween elementary and compound interest, and the power of compound interest.

Ordinary and Compound Interest

Elementary interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for ordinary interest:

Principal × Rate × Time = Interest

Step Two. Practice using the ordinary interest formula.

Example 1: $100 Deposit at a ordinary interest rate of 5% held for one year is:

Elementary interest in this example is $Five.

Example Two: $100 Deposit at a ordinary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Ordinary interest in this example is $Five.

Step Three. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two elementary interest formulas together.

Total future amount (with ordinary interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the elementary interest formula to our three year example.

Total future amount (with plain interest) = $100 + ($100 × 0.05 × Three) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year screenplay. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with elementary interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a yam-sized difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Excellent Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is utterly difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: accomplish significant extra education and training after graduating from high school and embark saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a ordinary interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Three) = $Five,900

If your receive $500 in plain interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Individual Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate ordinary and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating private wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do step by step climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will strike the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a superb deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to finish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to begin saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Trio,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of comeback (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Three,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this neat sum is the result of saving $Three,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but reminisce that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a flawlessly achievable purpose for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween elementary and compound interest, and the power of compound interest.

Plain and Compound Interest

Elementary interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for elementary interest:

Principal × Rate × Time = Interest

Step Two. Practice using the plain interest formula.

Example 1: $100 Deposit at a ordinary interest rate of 5% held for one year is:

Ordinary interest in this example is $Five.

Example Two: $100 Deposit at a elementary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Plain interest in this example is $Five.

Step Three. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two elementary interest formulas together.

Total future amount (with plain interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the plain interest formula to our three year example.

Total future amount (with ordinary interest) = $100 + ($100 × 0.05 × Three) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year script. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with plain interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a large difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Superb Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is utterly difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: accomplish significant extra education and training after graduating from high school and begin saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a ordinary interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Trio) = $Five,900

If your receive $500 in elementary interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Individual Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate ordinary and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating private wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do little by little climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will hammer the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a superb deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to finish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to commence saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Three,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of comeback (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Three,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this neat sum is the result of saving $Three,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but recall that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a ideally achievable objective for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween elementary and compound interest, and the power of compound interest.

Elementary and Compound Interest

Ordinary interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for ordinary interest:

Principal × Rate × Time = Interest

Step Two. Practice using the ordinary interest formula.

Example 1: $100 Deposit at a plain interest rate of 5% held for one year is:

Elementary interest in this example is $Five.

Example Two: $100 Deposit at a ordinary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Plain interest in this example is $Five.

Step Three. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two ordinary interest formulas together.

Total future amount (with elementary interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the ordinary interest formula to our three year example.

Total future amount (with elementary interest) = $100 + ($100 × 0.05 × Trio) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year screenplay. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with elementary interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a yam-sized difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Fine Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is utterly difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: finish significant extra education and training after graduating from high school and embark saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a elementary interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Three) = $Five,900

If your receive $500 in ordinary interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Individual Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate ordinary and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating individual wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do step by step climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will strike the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a good deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to accomplish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to embark saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Trio,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of comeback (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Trio,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this clean sum is the result of saving $Three,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but recall that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a ideally achievable purpose for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween ordinary and compound interest, and the power of compound interest.

Elementary and Compound Interest

Plain interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for plain interest:

Principal × Rate × Time = Interest

Step Two. Practice using the plain interest formula.

Example 1: $100 Deposit at a plain interest rate of 5% held for one year is:

Plain interest in this example is $Five.

Example Two: $100 Deposit at a elementary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Elementary interest in this example is $Five.

Step Three. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two ordinary interest formulas together.

Total future amount (with ordinary interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the ordinary interest formula to our three year example.

Total future amount (with elementary interest) = $100 + ($100 × 0.05 × Three) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year script. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with ordinary interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a phat difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Superb Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is utterly difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: accomplish significant extra education and training after graduating from high school and embark saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a plain interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Three) = $Five,900

If your receive $500 in elementary interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Individual Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate plain and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating individual wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do little by little climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will hammer the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a fine deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to finish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to embark saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Trio,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of comeback (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Trio,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this clean sum is the result of saving $Three,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but reminisce that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a ideally achievable aim for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween plain and compound interest, and the power of compound interest.

Plain and Compound Interest

Ordinary interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for elementary interest:

Principal × Rate × Time = Interest

Step Two. Practice using the ordinary interest formula.

Example 1: $100 Deposit at a ordinary interest rate of 5% held for one year is:

Ordinary interest in this example is $Five.

Example Two: $100 Deposit at a elementary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Plain interest in this example is $Five.

Step Trio. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two plain interest formulas together.

Total future amount (with ordinary interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the elementary interest formula to our three year example.

Total future amount (with plain interest) = $100 + ($100 × 0.05 × Trio) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year script. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with elementary interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a phat difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Superb Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is utterly difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: finish significant extra education and training after graduating from high school and begin saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a plain interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Trio) = $Five,900

If your receive $500 in ordinary interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Individual Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate ordinary and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating individual wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do little by little climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will hammer the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a good deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to accomplish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to commence saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Three,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of comeback (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Trio,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this clean sum is the result of saving $Trio,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but reminisce that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a flawlessly achievable purpose for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween plain and compound interest, and the power of compound interest.

Ordinary and Compound Interest

Plain interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for ordinary interest:

Principal × Rate × Time = Interest

Step Two. Practice using the ordinary interest formula.

Example 1: $100 Deposit at a ordinary interest rate of 5% held for one year is:

Elementary interest in this example is $Five.

Example Two: $100 Deposit at a elementary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Elementary interest in this example is $Five.

Step Trio. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two plain interest formulas together.

Total future amount (with plain interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the elementary interest formula to our three year example.

Total future amount (with elementary interest) = $100 + ($100 × 0.05 × Trio) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year screenplay. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with elementary interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a ample difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Good Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is utterly difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: accomplish significant extra education and training after graduating from high school and commence saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a plain interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Trio) = $Five,900

If your receive $500 in plain interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

Principles of Microeconomics

Principles of Microeconomics/How to Accumulate Individual Wealth

By the end of this section, you will be able to:

  • Explain the random walk theory
  • Calculate plain and compound interest
  • Evaluate how capital markets convert financial capital

Getting rich may seem straightforward enough. Figure out what companies are going to grow and earn high profits in the future, or figure out what companies are going to become popular for everyone else to buy. Those companies are the ones that will pay high dividends or whose stock price will climb in the future. Then, buy stock in those companies. Presto! Multiply your money!

Why is this path to riches not as effortless as it sounds? This module very first discusses the problems with picking stocks, and then discusses a more reliable but undeniably duller method of accumulating private wealth.

Contents

The chief problem with attempting to buy stock in companies that will have higher prices in the future is that many other financial investors are attempting to do the same thing. Thus, in attempting to get rich in the stock market, it is no help to identify a company that is going to earn high profits if many other investors have already reached the same conclusion, because the stock price will already be high, based on the expected high level of future profits.

The idea that stock prices are based on expectations about the future has a powerful and unexpected implication. If expectations determine stock price, then shifts in expectations will determine shifts in the stock price. Thus, what matters for predicting whether the stock price of a company will do well is not whether the company will actually earn profits in the future. Instead, you must find a company that is widely believed at present to have poor prospects, but that will actually turn out to be a shining starlet. Brigades of stock market analysts and individual investors are carrying out such research twenty four hours a day.

The fundamental problem with predicting future stock winners is that, by definition, no one can predict the future news that alters expectations about profits. Because stock prices will shift in response to unpredictable future news, these prices will tend to go after what mathematicians call a “random walk with a trend.” The “random walk” part means that, on any given day, stock prices are just as likely to rise as to fall. “With a trend” means that over time, the upward steps tend to be larger than the downward steps, so stocks do step by step climb.

If stocks go after a random walk, then not even financial professionals will be able to choose those that will strike the average consistently. While some investment advisers are better than average in any given year, and some even succeed for a number of years in a row, the majority of financial investors do not outguess the market. If we look back over time, it is typically true that half or two-thirds of the mutual funds that attempted to pick stocks which would rise more than the market average actually ended up doing worse than the market average. For the average investor who reads the business pages of the newspaper over a cup of coffee in the morning, the odds of doing better than full-time professionals is not very good at all. Attempting to pick the stocks that will build up a fine deal in the future is a risky and unlikely way to become rich.

Many U.S. citizens can accumulate a large amount of wealth during their lifetimes, if they make two key choices. The very first is to finish extra education and training. In 2014, the U.S. Census Bureau reported median earnings for households where the main earner had only a high school degree of $33,124; for those with a two-year associate degree, median earnings were $40,560 and for those with a four-year bachelor’s degree, median income was $54,340. Learning is not only good for you, but it pays off financially, too.

The 2nd key choice is to commence saving money early in life, and to give the power of compound interest a chance. Imagine that at age 25, you save $Trio,000 and place that money into an account that you do not touch. In the long run, it is not unreasonable to assume a 7% real annual rate of comeback (that is, 7% above the rate of inflation) on money invested in a well-diversified stock portfolio. After forty years, using the formula for compound interest, the original $Trio,000 investment will have multiplied almost fifteen fold:

Having $45,000 does not make you a millionaire. Notice, however, that this clean sum is the result of saving $Trio,000 exactly once. Saving that amount every year for several decades—or saving more as income rises—will multiply the total considerably. This type of wealth will not rival the riches of Microsoft CEO Bill Gates, but reminisce that only half of Americans have any money in mutual funds at all. Accumulating hundreds of thousands of dollars by retirement is a ideally achievable objective for a well-educated person who starts saving early in life—and that amount of accumulated wealth will put you at or near the top 10% of all American households. The following Work It Out feature shows the difference inbetween elementary and compound interest, and the power of compound interest.

Ordinary and Compound Interest

Elementary interest is an interest rate calculation only on the principal amount.

Step 1. Learn the formula for plain interest:

Principal × Rate × Time = Interest

Step Two. Practice using the plain interest formula.

Example 1: $100 Deposit at a elementary interest rate of 5% held for one year is:

Plain interest in this example is $Five.

Example Two: $100 Deposit at a elementary interest rate of 5% held for three years is:

$100 × 0.05 × three = $15

Elementary interest in this example is $Five.

Step Three. Calculate the total future amount using this formula:

Total future amount = principal + interest

Step Four. Put the two ordinary interest formulas together.

Total future amount (with ordinary interest) = Principal + (Principal × Rate × Time)

Step Five. Apply the ordinary interest formula to our three year example.

Total future amount (with plain interest) = $100 + ($100 × 0.05 × Three) = $115

Compound interest is an interest rate calculation on the principal plus the accumulated interest.

Step 6. To find the compound interest, we determine the difference inbetween the future value and the present value of the principal. This is accomplished as goes after:

Compound interest = Future Value – Present Valve

Step 7. Apply this formula to our three-year screenplay. Go after the calculations in

Step 8. Note that, after three years, the total is $115.75. Therefore the total compound interest is $15.75. This is $0.75 more than was obtained with plain interest. While this may not seem like much, keep in mind that we were only working with $100 and over a relatively brief time period. Compound interest can make a ample difference with larger sums of money and over longer periods of time.

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

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

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

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

The Housing Bubble and the Financial Crisis of 2007

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

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

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, request, consumption, and employment, and to the Fine Recession, which in the United States officially lasted from December two thousand seven to June 2009. During this time, the unemployment rate rose from 5% to a peak of Ten.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

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

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

It is utterly difficult, even for financial professionals, to predict switches in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they go after two rules: accomplish significant extra education and training after graduating from high school and begin saving money early in life.

What is the total amount of interest collected from a $Five,000 loan after three years with a ordinary interest rate of 6%?

Principal + (principal × rate × time)

$Five,000 + ($Five,000 × 0.06 × Three) = $Five,900

If your receive $500 in plain interest on a loan that you made for $Ten,000 for five years, what was the interest rate you charged?

Principal + (principal × rate × time); Interest = Principal × rate × time; $500 = $Ten,000 × rate × five years; $500 = $50,000 × rate; $500/$50,000 = rate; Rate = 1%

You open a 5-year CD for $1,000 that pays 2% interest, compounded annually. What is the value of that CD at the end of the five years?

Principal(1 + interest rate) time = $1,000(1+0.02) five =$1,104.08

What are the two key choices U.S. citizens need to make that determines their relative wealth?

Is investing in housing always a very safe investment?

Explain what happens in an economy when the financial markets limit access to capital. How does this affect economic growth and employment?

You and your friend have opened an account on E-Trade and have each determined to select five similar companies in which to invest. You are diligent in monitoring your selections, tracking prices, current events, and deeds taken by the company. Your friend chooses his companies randomly, pays no attention to the financial news, and spends his leisure time focused on everything besides his investments. Explain what might be the spectacle for each of your portfolios at the end of the year.

How do bank failures cause the economy to go into recession?

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

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $Five,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns Four.75%. After thirty years, how much more will Alexx have than Spenser?

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