Economic Environment of Business

Economic Environment of Business

These notes were taken at Rice University in a Management program  held in May 2011, that was conducted by Dr.  Barbara Ostdiek.

“Teach a parrot supply and demand and you will have an economist”

Macroeconomics:

Aggregate Demand: Goods & Services

Aggregate Supply: Production

“You can only eat the potatoes that have been produced”

Goods & Services: Consumption + Investment + Government + Exports = GDP

Gross Domestic Product

Production: Labor Cost + Capital Costs + Material Costs + Productivity + Capacity = GDP (Its more complicated to estimate:  should include depreciation, Tax evasion, unofficial economy… Its easier to calculate he GDP using the Aggregate demand)

Financial Markets = Money & Financial Assets (Do not add anything to GDP)

Analogy between Agriculture (Tobacco and cotton) in South USA (using slaves) was very easy way to make much money, so they did not had to be creative. Same situation today with the Oil Rich countries, and they end being underdeveloped. What you do to invest that money makes a big difference (ie Norway vs Venezuela)

1)   Kaynes: The government SHOULD do something!

Economists should be as competent as the dentist. We understand it. We should be able to fix it.

Paul Kruman supports Keynes thinking!

2)   Frederic  Von Hayek: The market is aggregating to get the best outcome (Adam Smith invisible hand)

Hayek suggest on having a very robust Production Function to avoid recession => Aggregate Supply (Focus on the production)

3)   Milton Freeman: Inflation is a monetary phenomenon. This was the foundation of Active Central Banks.

Recessions (if short) could be even good, as they can clean or make companies more efficient.

When international Operations:

Goods: Trade balance (X-M)

Financial Markets: (S-I).

The exchange rates are affected by both, S-I and Goods (X-M)

The environment laid the foundation of the 2007 crisis was:

1)   Greenspan was focused only in Inflation. He lowered interest rates to about 1%.

2)   The Chinese Government kept the Yuan fixed too low for too long. There were also huge imports from China,  that helped lowering inflation pressure.

Then Banks “got creative” offering loans to people that did not qualified for the credit, and then packaging and selling as a much better credit.

Increasing the supply:

Short Run: “Hits the wall”. It’s going to have a significant price impact

Long run: You can increase the capacity and avoid a significant price impact increase.

Fiscal Policy: Change Taxes, Increase Government Spending…

Its completely independent from the FED.

Monetary Policy: Vary Money Supply (Controlled/Regulated by the FED to the Central Bank). When a Regulator or Central Bank is independent, the more independent, the lower Inflation the country will have! Tuning Monetary Policy is “Keynesian thinking”

Quantitative Easing (QE): Going directly to the short end market (Corporate Bond Market, Loan Market) and affect the money supply. Not picking a sector. They simply printed the money!

Purpose. Cleaning the Bad debts to Banks. They created demand for the “crappie securities”. If the papers that they bough are defaulted, the only consequence will be inflation, as they would not be able to sell them. They still hold it in their balance.

Burden of the National Debt:

1930 Crisis: The deficit helped bit Hitler! (WWII). We are still paying that debt

The Multiplier Model:

Marginal Propensity to Consume (MPC)

Example: 60%  MPC spent by government will induce (100 $ /person => I will increase spending if MPC is  60% can have an increase in GDP of 250 $)

Aggregate Production Function

Output vs Capital/Hours Worked: Growing linear but gets flat!

Technology can help increase the Capital/Labor output

·      Old Model: GDP= Function (K,L) & Technology (K= Capital // L= Labor )

·      New Model: GDP= Function (K,L, T) Technology is Endogenous  (By investing you can rapidly increase productivity. You can spend on education, take risks on entrepreneurship…). Example: What Deming did in Japan really increased productivity!

GROWTH:

We often lose sight on how important the average rate of growth is for an economy. Example: In Japan they had 1% average growth, but this was NOT enough.

70 rule: Years to economy doubles! 70/ number of years!

If growth is less than 9%: Rule : Divide 70 / Rate:

1% Growth: Requires 70 years to double!

2% Growth: 70/2= requires 35 years to double

Innovations is a BIG JUMP compared to scale economy. It brings more Capital & has high impact on the Output per hour worked!

What drives technological Innovation: Environment, Capital, Labor, Technology (Yes!)

What will be the engine of Growth?

GDP= C + I + G + X

X= Perhaps, In emerging markets!

I= Business Investments!