Economic Introduction

Demand is the ability and willingness to buy specific products or services at alternative prices in a given time period.

WHAT???

How much the buyers can and want to buy at different prices

Quantity

The law of demand:

At higher prices people want buy less products

How the price increases the

demanded quantity will decrease.

Market Participants and Interactions

Business firmsConsumers

Productmarkets

Factormarkets

Foreign marketparticipants

Foreign marketparticipants

supply

supply

demand

demand

Import

Export

Product Market: Where finished goods and services are bought and sold

Factor Market: Where factors of production ( Labor) are bought and sold

In other Country In “Our” Country

The U.S economy is getting slower. It's expected in Asia and in Europe also.

-If somebody increases his fortune from „10” to „20” than the growth will be 100%

-But to keep on increasing 100% now he needs to get to the wealth of 40 which is another 20 unit. So every time is more difficult to provide the same growth %.

10

100%

20

40

+10

+20 100%

“Macro slowdown”

1930 1940 1950 1960 1970 1980 1990

Annual growth

GR

OW

TH

RA

TE

(pe

rcen

t pe

r ye

ar)

Long-term average growth (3%)

Recession

Zero growth

0

35

10

15

20

-10

-5

What is a recession?

Negative economic growth during two or more quarters (3months)

The financial crisis

Stock Exchange

• To provide the growth we need production and consumption.

The USA trend = consumption is financed of credits

• Crisis effect: a few Bankrupts They introduce stricter credit acces conditions Consumption decreases

EFFECTS OF THE STRICTER CREDIT ACCESS

The antecedents

If the American buy less T-shirts „made in China”

EFFECTS OF STRICTER CREDIT ACCESS

then China needs less T-shirt factories.

The bank gives me less

$$$, so I can't buy

more T-shirt.

EFFECTS OF STRICTER CREDIT ACCESS

Even if China finds new market possibilities…(… in Eastern Europe, where the living standards are increasing so does the

consumption so they want to buy more and more T-shirts).

Let's sell it in Romania,

now!!! So we need more factories.

To build a new factory they need credits. But credit access is much more difficult and expensive now,

so they will decide not to build the new factory.

We have to pay a lot of interests

after the credits. Is it worth???

more complex because of the price of the resources and the materials;

10 years ago everything was cheaper. Electricity was bought for production by the T-shirt and the computer producer as well who obviously has a higher profit.

2002 2003 2004 2005 2006 2007

PR

ICE

of

Ele

ctri

city

Then there was such a high demand of electricity that its price has increased and only the high-profit producer could buy it the other one has bankrupt which is not good for the economy.

EFFECTS OF STRICTER CREDIT ACCESS

• This is not the first wave of the crisis,

started in spring 2007: market was affected by the fall of the property’s price in the US.

In 2001 -after the DOT.COM boom and 11/09, 2 events that had a very bad result on the US economy -

FED (FEDERAL RESERVE) introduced very low interest for the banks in order to boost the economy.

Money flows to the factor market (for production and investment);

• (There is no point to keep money on the bank accounts, because it doesn’t give good interests)

So what happened? Why have we finished in a crisis?

The credit is cheaper The american starts to consume (credit financed spending).It is good for the economy because there are potential buyers to sell the products for.

I can get a lot of money from the

bank at low interests so I

can buy what I want

The credit is a product itself as well of the bank’s trade.It’s money with its own price. The interest will be the bank’s profit.

input

Output -The product

Output - The credit

Price = costs of the production + profit

Price = amount of credit + interest

Credit ≈ Product

The bank interested as well to give more and more creditsBut only in case that it can be sure of the amortization or of the cover. The debtor supposed to have:•an adequate income •cover with high value in case.

With the boom of the price of the property the house value now is higher than the former requested covers to get credits Almost everybody could have a credit covering it by the house so the banks tried offer more and more credits their clients without real control

(there were many cases when even then basic personal data had errors of the credit’s administration.

… there became credit-based and interest (profit) derivative „products”

if somebody buys a share to invest it’s possible that it’s value increases. Nowadays it was possible to “invest in credits”.

So the one gives its money in order to give it to a third person as a credit. And for him the part of the interest will be the profit. The circle closes when the American citizen gets another credit (because he has got cover by the increasing value of the property,) and the money received of the credit he invests in another credit.

The process of what happened can be modeled as a Pyramid-game.

What happens with this complex “credit-pyramid” when the price of the property starts to fall, so the value doesn’t cover the credit any more. No more security. At the same time the debtor looses its job, or in extremely case, it’s impossible to find him. So what can the bank do?

•because of the low interests made demand the market was over-heated and the market price reached unexplained levels•demand started to tone down, partly explained with the augmenting unemployment which wasn’t cured by the low interests neither…..

D

Q

P

But why does the price of property starts to fall?

Lower demand Decreasing price

To nowhere; the base of the process is the bad credit and the short-run expected profit.

The money that has gone never has been produced.

To where did that amount of money disappear?

Why is the US not the only country affected by the crisis? Why is it a global problem?

Because the financial processes are the most globalized in our highly globalized world, and the main-character is still the United States.

When somebody goes to the bank to deposit money on his bank account, it doesn’t mean that the money was put in a safe; the bank starts to tie it up, in order to get a higher profit then the fund and its provided interest by the bank. Takes out the money to the market:•gives it to other banks as a credit•buys another country’s money (foreign currency)•buys shares on the stock exchange

So there is a bank which get one “money fund” from another bank called X, and than the same bank buys another “money fund” called Y from a third bank, Our bank puts the two different money funds together and sells it as Z, and so on, we can roll the rock over and over…..

So the credit derivatives spread out all around the world, and sometimes it is impossible to know their background when it arrives to an other country’s investor, because of so many possible combinations. It already happened last year that the banks didn’t know how much money they had laid out.

Mexico’s stock exchange and currencies are not determined by their own investors.

They are very depended of higher investor units who think that there is a possibility to earn a lot of money on these risky “ambitious” markets like Mexico, Hungary or China or South Africa.

Why does the stock exchange decreases? Why are the currencies of other countries loosing their value like in Mexico and in many other

countries?

In Mexico the people use donkeys as

transportation, so it's not a developed country,

better if we don't trust in its risky market

When investors hear the “high risk” word because there is a bankrupt of a historical financial institute they start to sell their shares of the risky countries´ market shares

or to get rid of these nations` money (currency) .Everybody( the big investors) sells the PESO (its demand has decreased) the price of it will decrease as well. They start to buy the developed markets money (USD, EUR,) because those cannot crash in.

Hysteria?

In the developing countries (and even the most developed countries):A very big part of the decline of the value of the “papers” is the hysterical reaction of the investors for the “cloudy future”.

Absolutely right….

Let's sell our pesos and our

Mexican shares.

To release the mentioned effects and to get back the trustiness.What happens now among the banks, possibly can spread to the people as the following step.

It can destroy the best functioning banks as well very fast. If there is no bank no credit, no money.

The banks don’t want to give credits for the smaller participants of the financial system

The people take their money out from the bank and keep it at home “under the pillow”.

Why is the government intervention necessary?

The basic pillars of the financial system of the last 200 hundred years would disappear. Which means that it would be worse than a “crisis”

Since the 30`s it’s the biggest crisis all around the world. Former expectations have disappeared that it can be over very fast with stabilizing some of those institutes which suffered bankrupt.

The frightened creditors will take deeper and deeper those companies who already have got “liquidation” problems.

How long does it take?

Nobody knows

There are “rescue mechanisms”

But the question is?...

For how long the governments and international monetary institutesare able to save the companies that they are “dropping away”?

Recovery

There are prepared and moveable funds to inject more money in the financial system.•IMF•World Bank

After that more than 1 year the world's economy is in recession, now the experts and investors are a bit more optimists, but the after-effects of the crisis now are getting to their climax.

Highest unemployment rateMore companies are closing downThe exchange rates of the weaker currencies are getting to

their lowest point

The summary of the Domino-effect

The US economy was affected

badly by some events around the year 2000.

In order to boost the economy the FED

introduced low credit interests.

High investment and production started

The law interest also motivated the

consumer to buy more products, even if the consumption was financed by

creditsBecause of the increasing

property-price people (investors) afford more credits,

in order to give it another debtor and to get the fastest

profit by the interestsBy the every time

“rolled-over” credits there became a

credit-pyramid system with many

participants

How the unemployment increased, people had

less money to new houses, so it's demand

started to decrease

For the law of the demand the price of the houses

decreased as well, therefore the cover for the

given credits started to disappear

After the first bankruptcies, the banks had to raise the level of the interests and to create stricter credit access

With less credit the companies had

difficulties to pay their debts and their

employees.

The companies started to downsize

their plants and employees.

People without job, don't have income, so

they will buy less products.

If the consumption decreases, the

production will decrease as well, and the company will the bankrupt again…

A lot of production, a lot of consumption

means a good (growing) economy

With the every time closing down firms, banks

and increasing unemployment, the economy crashes

Reference:

(2008) A világgazdasági válság okai (Reasons of the world financial crisis) Index – Web News, http://index.hu/, 15 October, 2008

(2008) Drop 'til you shop, The Economist, http://www.economist.com/world/unitedstates/displaystory.cfm?story_id=12536256 , 30 October, 2008

Mihály Sugár /sugmis/