Chapter 7: Finance and Financial Markets. The first six chapters covered the “macro” world. But what about all those things that happened on Wall Street that got us into trouble? Yes, there are hundreds of books about the stock market and Wall Street. But do they explain how Wall Street concepts connect to the larger economy? Do they explain “collateralized debt obligations” in plain English? And what you need to know about the financial markets and “retail” financial people like broker-dealers and financial advisers? And what about all those terms you see daily about real estate? Is a stock market short sale the same as a real estate short sale? This chapter explains the most important financial markets and instruments of today.

Chapter 8: Trade and International Economics. What is globalization, and how will it affect you? What makes the dollar gain against the euro, or vice versa? And what about those trade deficits? How does (and should) foreign trade work in a “new” economy? And how will that affect your job, the cost of living, and your life?

In the nineteenth century, the historian Thomas Carlyle was the first to refer to economics as “the dismal science.” (To be fair, Carlyle wasn’t exactly a bundle of laughs himself.) Since then, economics has labored under the burden of descriptions like “boring,” “complicated,” and “dry.”

It doesn’t have to be that way, and I hope this book will convince you otherwise. Economics is about the most basic human activities: what we produce, how we produce it, and how we consume it. It’s concerned, in other words, with human behavior—in fact, in recent years the field of behavioral economics has risen to prominence because of best-selling books like Freakonomics, The Black Swan, and Predictably Irrational.

In this book, we’re interested in what different economic terms and concepts mean, and how they affect us. So, to rather freely adapt a phrase made popular in the movies: read on and prosper.

CHAPTER 1

The Basics

If you have taken an introductory economics course in college or have read a basic economics textbook, you can probably skip this chapter and go right to the next one. But if you want to refresh your grasp of basic economic terms, read on. Feel free, as you go through this book, to flip back to this chapter if you get confused by some of the terminology.

A GLOSSARY OF BASIC ECONOMIC TERMS

Asset. Something that is owned. For businesses, it can take the form of things such as factories, products, and equipment. Assets can also be intangibles such as patents, trademarks, and copyrights. These kinds of things often fall into the category of intellectual property, a concept that’s the subject of a growing body of law. In the age of the Internet, determining the value of an intangible asset has grown very complicated, and is probably going to become more so in the future.

Broker. Someone who sells or buys things on behalf of other people. For example, a mortgage broker buys and sells mortgages. An insurance broker arranges the sale of insurance policies to clients, and so on. The term brokerage firm usually refers to a company that deals in stocks. Brokers often make recommendations to their clients about what to buy and sell, but ultimately the buy-or-sell decision rests with the client.

Capital. Originally, this word described one of the factors used to produce goods (the others included things like land and labor). In today’s economy, “capital” generally refers to cash as well as to material goods like manufacturing equipment, tools, and so on. The term financial capital is used when talking about the monetary resources entrepreneurs use to create their products or services.

Competitive Advantage. It’s the nature of capitalism that businesses compete against one another. Each one tries to find some special way of beating its rivals, something that makes it stand out. That something is competitive advantage (also sometimes called the competitive edge). This is one of the most valuable tools a company has to ensure its growth, and companies try to protect their competitive advantages from all rivals.

Consumer. Anyone who uses goods and services that companies produce. Consumers have become a major driving force in the U.S. economy, and companies compete fiercely for their business. To this end, they spend a lot of time analyzing consumers, trying to figure out their buying patterns, their psychology, and so on.

Credit. Money that’s loaned to someone or something. Credit can be in the form of a mortgage, a car loan, a line of credit through a credit card, or any one of numerous other forms. When you have credit, that’s money that has been loaned to you by someone else. If you’re a creditor, you’ve loaned money to someone, and they’ll have to pay it back to you, usually with interest.

Debt. Something you owe to someone else. Personal debt has become a huge issue in the United States in recent years, and many people, as a result of their exploding debt, have suffered bankruptcies and foreclosures. However, some debt can be good—for example, if it’s used to buy something that will produce value (like a business asset) or increase in value over time (like certain real estate investments), or something that you need but will cost more in the future. Bad debt is when you purchase something you don’t need and can’t afford.

Elasticity. In the context of economics, the measure of the ability of an economy to change rapidly in response to circumstances. In a more technical sense, it’s the ratio between the percentage change in two variables (for example, supply and price). For instance, if the price of a product rises slightly and immediately the demand for it falls dramatically, the product is said to have high elasticity. The price of a product such as gasoline, on the other hand, can rise quite a lot before demand drops substantially, so it’s said to have low elasticity.

Entrepreneur. Someone who starts a business and takes responsibility for its success or failure. The term has also come to mean someone who shows enterprise, initiative, and daring in the business community. Even though many new businesses fail, we still respect those who are brave enough to follow their dreams. Small businesses, started and operated by entrepreneurs, represent 99 percent of all U.S. businesses, and for many they represent American capitalism in its purest form.

Forecast. An estimate of where the economy, a business, or some feature of either is going. Different government agencies, as well as nongovernmental organizations, make economic forecasts, some of which can affect the performance of the markets. Businesses use forecasts to plan their goals and budgets. Keep in mind, though, that a forecast is a guess. It’s usually an educated guess, but still a guess.

Free Enterprise. An economic system in which markets and companies are privately owned and are free to compete against one another with minimal government restrictions. This is the system that exists in the United States. It’s sometimes referred to as laissez-faire capitalism or free-market capitalism.

Innovation. The process by which companies come up with new products and services. Often, companies’ research and development (R&D) divisions take the lead in driving innovation. An innovation goes beyond an “invention” in that it becomes a product or service that people will buy—that is, there’s a market for it. Some companies (for example, Apple and Google) have built their competitive advantage on innovation—often with “disruptive” innovations that really change markets, in contrast to just adding refinements to existing products or services.