Strategy Thoughts & Economics for MChE in a Day Class

11/09/2010
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AIChE Annual Conference, 2012, Pittsburgh, D. Matonis
Strategy and Economics
October 2012
AIChE Annual Conference
Dr. Diana T. Matonis, PhD, MBA
© Midstream Energy Group 2012
Keynes on Marshall
“Marshall… arrived very early at the point of view that the bare bones of economic
theory are not worth much in themselves and do not carry one far in the direction of
useful, practical conclusions.
Keynes, John Maynard (1924). “Alfred Marshall, 1842-1924.” The Economic Journal. v34, n135 (September), p. 342
Topics:
What to Keep in Mind during this entire presentation!
Basic Economic Concepts
Measurement of Economic Performance
National Income and Price Determination
Financial Sector
Inflation, Unemployment, and Stabilization Policies
Economic Growth and Productivity
Open Economy: International Trade and Finance

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Keep In Mind! Two Approaches
The Subjective or Ideological Approach
 Begin with a conclusion and collect data that fits your belief.
The Objective Approach
 Begin with the evidence and then work towards a conclusion.
“Good” academic research doesn’t know the conclusion of
the study before the study starts.
This distinction can be better understood by discussing
Alfred Marshall, Microeconomist 1842-2924
 The price and output of a good are determined by both
SUPPLY and DEMAND: the two that intersect at equilibrium.
Basic Economic Concepts
Production possibilities curve
Comparative advantage, absolute advantage,
specialization, and exchange
Demand, supply, and market equilibrium
Macroeconomic issues: business cycle, unemployment,
inflation, growth
1. Basic Economic Concepts

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Production Possibilities
Assumptions:
 Full Employment
 Fixed Resources and Technology
Movements
 Along curve shows opportunity cost
 Outward shift illustrates economic growth
 Inward shift indicates destruction of resources
Producing Capital Goods will lead to greater economic
growth than producing consumer goods. (Butter will lead
to more growth than cell phones)
Supply and Demand Factors
Demand Changes when:
 Income changes
 Related Products, complements and substitutes, (price or
quality change)
 Expectations (future price change)
 Consumers (more or less added)
 Tastes, Fads, Preferences change

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Demand Increase: As Demand Increases, Price and
Quantity Increase as well.
P1
P2
Q1 Q2
S1
D1
D2
Price
Quantity
8
Business Cycles
The increases and decreases in Real GDP consisting of
four phases:
 Peak: highest point of Real GDP
 Recession: Real GDP declining for 6 months
 Trough: lowest point of Real GDP
 Recovery: Real GDP increasing (trough to peak)

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9
Business Cycle
Peak -- Greatest spending and lowest unemployment.
Inflation becomes a problem.
Contraction/Recession -- Reduction of spending levels and
increasing unemployment. Some cyclical unemployment
begins.
Trough -- Least spending and highest unemployment
Expansion -- Spending increases and unemployment
decreases
Full Employment
Are Business Cycles Real?

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1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Year
-4
-2
0
2
4
6
8
10
12
14AnnualPercentChange
-60
-30
0
30
60
90
120
150
180
210
GDP Growth
Inflation
Oil Prices, Inflation, Unemployment and the US
Economy
Oil Price
1. Basic Economic Concepts – End Slide
Measurement of Economic
Performance
National income accounts
 Circular flow
 Gross domestic product
 Components of gross domestic product
 Real versus nominal gross domestic product
B. Inflation measurement and adjustment
 Price indices
 Nominal and real values
 Costs of inflation
C. Unemployment
 Definition and measurement
 Types of unemployment
 Natural rate of unemployment
2. Measurement of Economic Performance

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Circular Flow of Economic Activity
Households supply resources (land, labor, capital,
entrepreneurial ability) to the resource market. Households
demand goods and services from businesses.
Businesses demand household resources and supply goods
and services to the product (factor) market.
The total dollar (market) value of all final goods and
services produced in a given year.
Expenditure Formula:
Consumption (C) +
Business Investment (I) +
Government Spending (G) +
Net Exports (Xn)
Gross Domestic Product

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GDP: What Counts:
Goods Produced but not Sold (I)
Goods produced by a foreign country (Japan) in the
U.S. (Honda, Toyota)
Government spending on the military
Increase in business inventories
GDP: What DOES NOT count:
Intermediate Goods (Tires sold by Firestone to Ford)
Used Goods
Non-Market Activities (Illegal, Underground)
Transfer Payments (Social Security)
Stock Transactions

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Inflation
Rise in the general level of prices
Reduces the purchasing power of money
Measured with the Consumer Price Index (CPI)
 Reports the price of a market basket , more than 300
goods that are typically purchased by an urban
household
Types of Inflation
Demand Pull Inflation: ‘too much money chasing too few
goods.”
 AD Curve will shift to the right, resulting in a higher
Price Level and greater Output (until reaching Y*
Cost-Push Inflation: Major cause is a supply shock-
OPEC cutting back on oil production
 AS Curve will shift to the left resulting in a higher Price
Level and a decrease in Real GDP.

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Inflation: Winners & Losers
Winners:
 Debtors who borrow money that will be repaid with
“cheap” dollars.
 Those who have anticipated inflation
Losers:
 Savers (especially savings accounts)
 Creditors (Banks will be repaid with those “cheap”
dollars
 Fixed-Income Recipients (retirees receiving the same
monthly pension)
National Income and Price
Determination
Aggregate demand
 Determinants of aggregate demand
 Multiplier and crowding-out effects
Aggregate supply
 Short-run and long-run analyses
 Sticky versus flexible wages and prices
 Determinants of aggregate supply
Macroeconomic equilibrium
 Real output and price level
 Short and long run
 3. Actual versus full-employment output
3. National Income and Price Determination

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Aggregate Supply/Demand Curve
It is based on the theory of John Maynard Keynes
The AD/AS model is used to illustrate the Keynesian model of
the business cycle.
3. National Income and Price Determination
4. Financial Sector (Money and
Banking)
Money, banking, and financial markets
 Time value of money (present and future value)
 Measures of money supply
 Banks and creation of money
 Money market
 Loanable funds market
Central bank and control of the money supply
 Tools of central bank policy
 Quantity theory of money
 Real versus nominal interest rates
4. Financial Sector (Money and Banking)

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Present Value, Future Value
If you were to be promised $10,000 due in one year
when interest rates are 5-percent, your investment
would be worth $9,523.81 in today’s dollars.
$9,523.81 is the amount a borrower would need to set
aside today to be able to meet the promised payment of
$10,000 in one year is called the Present Value (PV).
05.1
000,10$
81.523,9$ =
Copyright © 2009 Pearson Addison-
Wesley. All rights reserved. 19-24
Federal Reserves
Bank lending and money supply are related by some
multiple to the level of bank reserves
Federal Reserve exercises control over bank lending
and money supply by altering the level of reserves in
the system and influencing the deposit creation
multiplier
Fed accomplishes these objectives by changing the
reserve requirements and by changing the actual
amount of reserves held

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The Federal Reserve System (FED)
Control Monetary Policy
Headquartered in Washington D.C.
12 Federal Reserve Districts
Board of Governors (7 members) is the central authority
Members are appointed by the President and confirmed
by the Senate with staggerred 12 year terms
26
Banks and Balance Sheets
Assets Liabilities
Reserves $15,000 in Checkable Deposits $100,000
Securities $15,000
Loans $70,000
If the current reserve requirement is 10%:
1. What is the amount of new loans this bank can generate?
Checkable deposits $100,000 with a 10% reserve requirement =
$10,000.
2. The bank has $15,000 in reserves, $5,000 of those are excess reserves
and can be loaned out.

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Balance Sheet Description: The
Banks
Citibank
∆R -$100 ∆D -$100
Chase
∆R +$100 ∆D +$100
Federal Reserve Bank of New York
∆R +$100 (Chase)
∆R - $100 (Citibank)
Any change in Bank Reserves is noted on the liability side of the
Federal Reserve
Federal Reserve
Working
balance
in spending
and
tax revenues
Fed’s most important tool to alter reserves

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Fed Exchange Market Intervention
Suppose that the Federal Reserve is
concerned about an excessive
downward movement of the US
exchange rate. It intervenes by
using its holdings of foreign
currency to buy dollars (then
remove the dollars from the system).
Inflation, Unemployment, and
Stabilization Policies
Fiscal and monetary policies
 Demand-side effects
 Supply-side effects
 Policy mix
 Government deficits and debt
Inflation and unemployment
 Types of inflation
 Demand-pull inflation
 Cost-push inflation
 The Phillips curve: short run versus long run
 Role of expectations
5. Inflation, Unemployment, and Stabilization
Policies

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Fiscal Policy
Using Taxes and Government spending to stabilize the
economy.
Controlled by the President and Congress
Discretionary Fiscal Policy: Congress must take action
(change the tax rates) in order for the action to be
implemented.
Automatic Stabilizers: Unemployment benefits,
Progressive Tax System, these changes are implemented
automatically to help the economy.
Policies
Types of Fiscal Policy
Expansionary - TODAY?
 Used to Fight a Recession
 LOWER TAXES
 INCREASE GOVERNMENT SPENDING
Contractionary
 Used to fight Inflation
 RAISE TAXES
 DECREASE GOVERNMENT SPENDING
Policies

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Recession
Mainstream economists must decide whether to target
the Price Level or Unemployment, before taking any
action.
Classical economists would argue to DO NOTHING.
Eventually, wages and resource prices must decrease
and when they do the SRAS curve will shift back to
the right, restoring the economy to its full-
employment output level and the original Price Level.
Policies
Decide Price Level - Expansionary
Fiscal Policy
Goal > Move the aggregate demand curve to the left.
Government spending leads to an increase in interest
rates.
 Foreigners demand more U.S. dollars to invest in bonds
 Results in appreciation of the U.S. dollar
 Decrease in Net Exports
 Decreases Investment
 Decreases AD
PriceLevel
Real GDP
AD1
P1
P2
AD2
AS
When Supply increases
(productivity surge in 90s)
more than demand,
Prices will fall.
GDP and employment go up
Policies

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Fight Unemployment
(Prof.) Phillips curve relates change in wages
and unemployment.
Short-Run Phillips Curve Inverse relationship
between inflation rate to the unemployment rate.
 Pull Inflation
 Prices rise, people demand higher wages
High unemployment reduces inflation
Inflation
Rate
(percent)
Unemployment Rate (percent)
A
B
7
2
4 6
SRPC1
5
OPEC decreasing Oil
supply causes shift
of Line
Policies
Economic Philosophies
Classical: Believe that the GOVERNMENT SHOULD NOT
interfere in the economy and in self-correction.
Keynesian: Believe that GOVERNMENT SHOULD interfere
in the economy. Most “mainstream” economists are Keynesians.
Central role is peoples expectations.
Rational Expectations: (More a model) Believe that any
consistent monetary and fiscal policy will be learned and
anticipated by the population. Thus, the outcome depends partly
on what people expect to happen So manipulate the economy to
induce false expectations(Policy Ineffectiveness Proposition).
Policies

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The Marshall Way
Step One: Math can be used, but only as a “shorthand
language.”
Step Two: Any math should be translated into words.
Step Three: A theory should be illustrated by examples
that are “important in real life.”
Step Four: With words and real world illustrations in
hand, you can now “burn the mathematics.”
Step Five: If you cannot find any real world examples,
burn the theory.
Marshall’s Lesson: Analysis must relate to the world we
observe.
Questions

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