Some more theoretical background Cost-Benefit Analysis Cost-Benefit Analysis Measuring Economic Performance Measuring Economic Performance System of National Accounts System of National Accounts Basic Macroeconomic Transmission Mechanisms Basic Macroeconomic Transmission Mechanisms Economic Analysis of Financial Systems – Transaction Costs and Assymetric Information Economic Analysis of Financial Systems – Transaction Costs and Assymetric Information Financial Crises Financial Crises

Cost – Benefit Analysis Basic method of economics Basic method of economics Applications: Applications: Solutions of Population Explosion Solutions of Population Explosion Why study in the Czech Republic? Why study in the Czech Republic? How can we limit corruption? How can we limit corruption?

Cost – Benefit Analysis Limiting corruption Limiting corruption The prevalence of corruption is primarily a function of its perceived costs and benefits The prevalence of corruption is primarily a function of its perceived costs and benefits The best way to reduce the benefits is to reduce the discretion officials have over funds and policies The best way to reduce the benefits is to reduce the discretion officials have over funds and policies Increase in the detection of corruption – Free press, various governmental agencies Increase in the detection of corruption – Free press, various governmental agencies Judicial independence Judicial independence

Cost – Benefit Analysis Question for discussion Question for discussion Can you rank countries according to the level of corruption? Can you rank countries according to the level of corruption?

Measuring Economic Performance GDP (Gross Domestic Product) = Income GDP (Gross Domestic Product) = Income GDP per capita - indicator of the living standard GDP per capita - indicator of the living standard Important Concepts: Important Concepts: Flows x Stocks Flows x Stocks Final x Intermediate Final x Intermediate Real x Financial Real x Financial GDP = real flow of final goods and services per year GDP = real flow of final goods and services per year

Measuring Economic Performance CPI (Consumer Price Index)- indicator of Inflation CPI (Consumer Price Index)- indicator of Inflation Real x Nominal GDP Real x Nominal GDP For comparison of the living standard in time – real GDP For comparison of the living standard in time – real GDP Real GDP = Nominal GDP / Price Index Real GDP = Nominal GDP / Price Index Rate of Unemployment Rate of Unemployment

Measuring Economic Performance Comparison in Space Comparison in Space Exchange rate and purchasing power adjustment Exchange rate and purchasing power adjustment

System of National Accounts Flow Diagram for the Macro Level 5 sectors: Households, Firms, Government, Foreign Countries, Financial System 5 sectors: Households, Firms, Government, Foreign Countries, Financial System All flows are real All flows are real Financial flows occur in the financial system Financial flows occur in the financial system GDP is created by firms, can be divided into consumption, investments, government purchases and net exports GDP is created by firms, can be divided into consumption, investments, government purchases and net exports

Economic Analysis of Financial Systems

Economic Analysis-Facts Stocks are not the most important source of finance for business Stocks are not the most important source of finance for business Issuing marketable securities is not the primary way of financing Issuing marketable securities is not the primary way of financing Indirect finance is more important than direct finance Indirect finance is more important than direct finance Banks are the most important source of external funds Banks are the most important source of external funds The financial system is heavily regulated The financial system is heavily regulated Only well established corporations have access to securities markets to finance their activities Only well established corporations have access to securities markets to finance their activities

Economic Analysis-The Role of Transaction Costs Possibilities for investing your $10,000 Possibilities for investing your $10,000 Direct lending: costs of a lawyer Direct lending: costs of a lawyer Direct investing in the stock market: costs of a broker Direct investing in the stock market: costs of a broker Indirect lending or investing through Financial Intermediaries has advantages: Indirect lending or investing through Financial Intermediaries has advantages: Economies of Scale Economies of Scale Development of Expertise Development of Expertise Diversification of Portfolio Diversification of Portfolio

Economic Analysis-The Effects of Asymmetric Information Adverse Selection (Before Transaction Occurs) Adverse Selection (Before Transaction Occurs) The potential borrowers who are the most likely to produce an undesirable outcome are the ones who most actively seek out a loan and are thus most likely to be selected The potential borrowers who are the most likely to produce an undesirable outcome are the ones who most actively seek out a loan and are thus most likely to be selected Moral Hazard (After Transaction Occurs) Moral Hazard (After Transaction Occurs) The borrower has incentives to engage in activities that make it less likely that the loan will be paid back The borrower has incentives to engage in activities that make it less likely that the loan will be paid back

Economic Analysis-The Role of Asymmetric Information Solutions to Adverse Selection Problems Private Production and Sale of Information Private Production and Sale of Information Free-rider problem Free-rider problem Government Regulation to Increase Information in Securities Markets Government Regulation to Increase Information in Securities Markets Financial Intermediation Financial Intermediation

Economic Analysis-The Role of Asymmetric Information Moral hazard in equity contracts: The Principal-Agent Problem Moral hazard in equity contracts: The Principal-Agent Problem

Economic Analysis-The Role of Asymmetric Information Solutions to the Principal-Agent Problem Production of Information Production of Information Monitoring - Costly state verification Monitoring - Costly state verification Government Regulation to Increase Information decreases costs of verification Government Regulation to Increase Information decreases costs of verification Corporate Restructuring Corporate Restructuring Debt Contracts Debt Contracts

Financial Crises Causing Factors Increase in Interest Rates Increase in Interest Rates Increase in Uncertainty Increase in Uncertainty Stock Market Decline Stock Market Decline  (1)Adverse Selection and Moral Hazard Problems Worsen  Decline in Economic Activity  Bank Panic  Back to =>(1)

Financial Crises Debt Deflation = Typical Financial Crisis + Unanticipated Decline in Price level  Adverse Selection and Moral Hazard Problems Worsen  etc