The Economy and You Essential Question: Why is an understanding of economic conditions important to your financial plan? Chapter 8

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-2 Learning Objectives Explain how economic factors impact financial decisions Understand how demographic changes will impact your future Analyze how events in the national and global economy might affect you

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-3 Economics and Your Financial Plan Economics –The study of choices People must decide: –what they will seek –how they will seek it –what they will do without Economists seek to understand ways that: – these decisions are made –the factors that influence them –the impact those decisions on others

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-4 Economics and Your Financial Plan Each of you makes economic decisions every day How much did you spend on lunch today? What options did you pass up when you made that decision? Larger decisions might include what kind of education or job training you seek

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-5 Economics and Your Financial Plan Economy –The system in which businesses, governments and the world as a whole interact In economics, we study: – choices made by individuals –decisions of business and governments –the world as a whole Economics is important to your financial plan because it involves making choices Good financial plans prepare for unexpected economic events Economics trends can impact financial decision making

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-6 Economics and Your Financial Plan Macroeconomics –Deals with broad issues that impact the economy as a whole. Microeconomics –Focuses on the study of individual choices or decisions made by smaller units, such as a firm. Economics is broken into two categories: –Macroeconomics –Microeconomics Most issues in this chapter are macroeconomics issues presented how they will impact you on a micro level

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-7 What does the study of economics have to do with your financial plan?

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-8 Good financial plans prepare for unexpected economic events and some economic trends can impact financial decision making

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-9 Math for Personal Finance Jill needs to decide about whether to spend $10,000 on a two-year degree that will qualify her for a $28,000 a year job or go to work and make $18,000 a year. She will work part-time while in college and make about $8,000 a year. (For purposes of this exercise disregard the effects of interest or inflation.) How long will it take Jill to recover her investment if she goes to college?

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-10 Math for Personal Finance Solution: Jill is giving up $10,000 a year in income for two years and spending another $10,000, so she will have a total of $30,000 invested in her education. Since the job with the degree will pay $10,000 per year more, she will need three working years to recover her investment of $30,000.

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-11 Demographic Factors Demographics –The study of human populations Demographers look at groups of people and their unique combination of features such as: –Race –Education –Age Understanding demographics can help us predict certain needs in advance

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-12 The Graying of America Baby boom –A period of very high birthrates that occurred between 1946 and 1964 The number of older people in the US is increasing at a faster rate than other age groups Families started after WW2 produced children in large numbers. Baby boomers make up about ½ of the US labor force today The leading edge of this group is beginning to reach retirement age.

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-13 The Graying of America Job opportunities will open up as boomers begin to leave their jobs Jobs in health care and other services that serve older people will be in high demand. Historically, many retired people relocate to warmer locations How will this affect housing prices where you live?

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-14 Immigration Immigration changes have produced important demographic changes in the US Hispanic Americans are a rapidly growing share of the population Jobs that cater to the needs of Hispanic Americans will be in high demand. Learning to speak Spanish might help create more job opportunities for your career advancement

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-15 Social Security FICA taxes are deducted from your paycheck These taxes pay for the Social Security system Many retirees rely on Social Security payments for at least part of their living expenses when they stop working

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-16 Social Security When the US first established Social Security, there were a lot of people paying into the system and very few drawing out Today about 3.3 workers are paying taxes for every one person drawing retirement Take a look at Figure 8.1 to see how there will be just over 2 workers for every one person drawing social security

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-17 Figure 8.1: Workers per Beneficiary Declining

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-18 Social Security Within the next 20 years, 76 million baby boomers will retire Who will pay for their retirement? FICA taxes might increase to cover these promised benefits Your benefits might be reduced for future retirees What does that mean to your financial plan? In Figure 8.2, see how even a small investment can help accumulate a large sum of money for retirement

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-19 Figure 8.2: Relationship Between Investment and Savings

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-20 Math for Personal Finance Assume that by 2040 there are 110 million workers in the labor force and 61 million retirees drawing Social Security How many workers will be paying in per retiree in 2040?

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-21 Math for Personal Finance Solution: 110/61 = 1.8 workers per retiree

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-22 What are some demographic trends that may affect your financial future?

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-23 Baby boomer retirements and immigration issues may affect your financial future

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-24 Factors in the Larger Economy Overall trends in the economy can have a big impact on our financial decisions It is important to have a basic understanding of how the economy behaves and the significant factors that can shape its future

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-25 Business Cycles Gross domestic product (GDP) –The total dollar amount of all final goods and services purchased in a given year One way we measure national economic activity is by keeping track of the GDP Observing the GDP and how it changes helps show how strong the economy is Refer to Figure 8.3 to see how the economy has grown over the past several decades.

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-26 Figure 8.3: Current-Dollar and “Real” GDP

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-27 Business Cycles When GDP is higher, it means businesses and individuals are selling more goods and the economy is growing When GDP is lower, it means fewer goods are being sold and the economy is shrinking

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-28 Business Cycles Recession –Period of time in which the economy is shrinking Depression –A severe recession Business Cycle –Alternating periods of shrinking and growth or expansion, in the economy Recessions are characterized by fewer goods being sold and higher levels of unemployment The risk of job loss is much higher Look at Figure 8.4 for an example of a business cycle

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-29 Figure 8.4: The Business Cycle

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-30 Math for Personal Finance Factory X in the United States pays 200 workers a total of $7 million each year to produce 1.5 million widgets. Foreign factory Y employs 150 workers at a total cost of $750,000 to produce 750,000 widgets. How do the costs per widget of the American and foreign factory compare?

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-31 Math for Personal Finance The cost per widget in the United States in $7 million/1.5 million, or $4.67 per widget The cost per widget overseas is $750,000/750,000, or $1 per widget

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-32 Business Cycle How does the business cycle affect you? You need to prepare for the next recession during good times Understanding the business cycle can help you make basic life decisions Finding a new job during a recession is more difficult than during a time of expansion

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-33 Inflation and Purchasing Power Inflation –A sustained increase in the general level of prices Things get more expensive during a time of inflation The purchasing power of your money also goes down $20 will not buy as much today as it bought a few years ago

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-34 Inflation and Purchasing Power Economics measures inflation by looking up prices on a set of about 300 goods and services that most people consume during the year Clothing, groceries, and electronic goods are all part of this “market basket” of goods

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-35 Inflation and Purchasing Power Consumer price index –The formal measure of inflation that tells us whether things overall are more expensive now than in the past This price data is then used to construct the CPI The CPI is compared to previous periods to tell us if prices are going up and by how much

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-36 Inflation and Purchasing Power Inflation reduces the value of our money Inflation is a fairly steady presence in our economy at some level Some of you may be protected by receiving regular increases in your paychecks

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-37 Inflation and Purchasing Power Another way to protect against inflation is to hold some of your wealth in assets that tend to increase in value by more than the rate of inflation Real estate is an investment that can be a good protection against inflation These assets also involve a higher degree of risk It is not good practice to place all your savings and investments in such assets

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-38 Globalization Global economy –The world in which all economies of all countries interact and depend on each other Today we live in a global economy Look at the typical products you buy Few items are made solely in the US A large and growing share of what we buy and sell is imported or exported Take a look at Figure 8.5 to see evidence of our global economy

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-39 Figure 8.5: Top U.S. Trade Partners

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-40 Globalization Wherever you work, the global nature of today’s economy will affect you You will deal with imported products or be involved in exporting products to other countries You will compete for customers and jobs with people from countries around the world

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-41 Globalization Develop the ability to adapt to a rapidly changing work force and business environment Recognize what types of skills are in demand Learn new skills as the environment changes Jobs, such as plumbers, electricians, or health-care-related jobs will be difficult to outsource

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-42 Globalization New issues will continue to emerge that will create new opportunities Some issues might cause you to revise your plan Economic issues, such as demographic trends and inflation, will just be a few issues that will affect this

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-43 What are some broad economic factors that might affect your financial future?

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-44 Economic growth or recession, globalization, and inflation might affect your future

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-45 Summary Understanding broad economic issues and concepts help you formulate plans and make better financial decisions Understanding demographics help you predict certain needs in advance and make informed career choices Two important demographic trends that will impact everyone in the US are the graying of America and increased immigration

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-46 Summary Economic activity can be measured by the gross domestic product (GDP) The economy goes through alternating periods of shrinking and growth (business cycle) Understanding the business cycle helps you make basic life decisions

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-47 Key Terms and Concepts Baby boom Business cycle Consumer price index Demographics Depression Economics Economy Global economy Gross domestic product Inflation Macroeconomics Microeconomics Recession

Copyright ©2014 Pearson Education, Inc. All rights reserved.8-48 Websites