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Economic Concepts Sample Essay

Economic Concepts Sample Essay.

Economic Concepts Sample Essay

University of Phoenix Material                      

Economic Concepts Worksheet

Economics Concepts

  1. A nominal interest rate is defined as “the opportunity cost of holding or using money.” Explain what you understand this definition to mean. A nominsal interest rate is a very low interest rate which enables the use of money for long duration of time by paying very low interest rate. The opportunity cost of holding money is the nominal interest rate and is computed by adding the expected inflation rate to the real interest rate. It is the opportunity cost of holding cash. The opportunity cost in this case refers to the interest rate foregone on alternative assets. A good example would be a person who chooses to hold $500 is giving up the opportunity to hold $500 of bonds which would pay a certain nominal interest rate. The nominal interest rate renders some additional purchasing power at the end of the loan period as well as compensation for inflation and thus, the nominal interest rate is the opportunity cost of holding and using money instead of in the form of other assets.
  2. When the economy is in a recession, the Federal Reserve usually cuts interest rates. Why would the federal government do this? Interest rates influence the actions of enterprises and during recession, the interest rates tend to fall. Ideally, this is because the Federal Reserve utilizes financial tools to drive down the rates. Using the law of demand and supply, consumers and borrowers are the determiners of the borrowing and paying interest rates.
  3. How does your saving and spending profile change depending on the state of the economy, i.e., whether the economy is in a recession versus expansion? Do interest rates play a role in your decisions? Why or why not? Yes, interest rates play a role in decision making. The fixing of interest rates depends on micro and macro-economic factors. It takes into account the spending and investing factors. Interest rates helps establish whether it is viable to spend or invest. A high interest rates is an incentive to save while a low interest rates motivates individuals to spend.
  4. If interest rates are at a level of 1% and expected inflation is 2%, would you prefer saving or spending your money? Justify your answer. Inflation is the rapid increase in prices over a period of time. The interest rates on the other hand is the rate of return on an investment. In the above case, it would be preferable to invest the money given that inflation increased over the period. Small variations in the interest rate should be ignored. It is better to invest and wait for the prices to fall.

Behavioral Economics Concepts

Mental accounting. Mental accounting is the practice of storing money in separate accounts depending on the source of generation and use (Chung, Hsu, Chang & Hsieh, 2014). For example, to diversify my funds, I ensure that maintain a different salary account from my other subsidiary account. Ideally, the safekeeping of money in different accounts enables me to diversify my portfolio and get to earn returns on diversified investments.

Herd behavior. It refers to the tendency of people to cohesively move in one direction without there being any mutual consensus. Such cases happens especially when people are not well informed and tend to go one after the other (Lee & Ahn, 2017). A good example would be copying the investment strategy of my allies. When I see my friend investing in real estate, I will also tend to follow them. In this case, though we did not have a consensus of investing in real estate, we ended up investing together in the same industry. In most case, such behavior presents itself because people perceive that an investment is generating good returns and so the others tend to dive in and copy the strategy.

References

Chung, J., Hsu, W., Chang, C., & Hsieh, N. (2014). The role of fluency on mental accounting.Advances in Consumer Research, 42, 779.

Garman, E. T., & Forgue, R. (2011). Personal finance. Cengage Learning.

Keown, A. J. (2013). Personal finance. Pearson.

Lee, W., & Ahn, J. Y. (2017). Measuring herd behavior: Properties and pitfalls. Dependence Modeling, 5(1), 316-329. doi:10.1515/demo-2017-0019

Mental accounting in decision-making for self versus others. (2017). Journal of Neuroscience, Psychology, and Economics, 10(2-3), 81-94. doi:10.1037/npe0000074

Zhao, L., Yang, G., Wang, W., Chen, Y., Huang, J. P., Ohashi, H., & Stanley, H. E. (2011). Herd behavior in a complex adaptive system. Proceedings of the National Academy of Sciences of the United States of America, 108(37), 15058-15063. doi:10.1073/pnas.1105239108

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