Islamic Finance and Banking 101

When we think of banking, we think of the United States, Europe and Japan, along with China, as examples of what banking is. However, in the Islamic world, there is a term called Islamic finance, or Islamic banking, which is very important to understand, especially to anyone doing banking work with the Middle East.

Islamic banking, or finance, refers to banking that works on the principles of Islamic law, while developing Islamic economies. Under the Sharia, which is Islamic law, the payment or even the acceptance of interest fees for loans is completely forbidden. In the 20^th century, several Islamic banks have applied the principles to private and semi-private institutions within the Muslim world.

The concept of Islamic finance came about during the Islamic Golden Age, when early forms of free markets were present and a market economy was just beginning during the 8^th to 12^th centuries. A monetary economy was created on the expanding levels of the currency, which was very stable and highly valued.

Several concepts and techniques were applied to Islamic finance, including partnerships, limited partnerships, capital, cheques, promissory notes and bills of exchange, all of which would become commonplace in future centuries.

One concept created in Islamic finance was Riba, which means excess. This was applied to prevent excess compensation without due consideration, which we would know as high interest rates. Therefore, applying interest under Islamic finance law was not something commonly done, but there were cases where it was.

Currencies that were based on guarantees by government, or based on materials such as base metals, were allowed to have interest applied ot them.

Interest-free banking, the most common trait of Islamic finance, continued into the 20^th century, however several Islamic banks saw interest as a necessary evil that could be used in a banking system based on profit and loss sharing. In the early 1970s, several Islamic institutions got involved in the concept of Islamic finance. The Conference of the Finance Ministers of Islamic Countries in 1970, a study done in Egypt in 1972, the First International Conference on Islamic Economics in 1976, the International Economic Conference in London in 1977 and more helped to determine if Islamic finance could work in the 20^th century. Through all of this, the Islamic Development Bank, which is a bank that covers many Islamic governments, was created in 1975.

In the past 20 years, interest free banking has gained a lot of praise and attention, especially in Pakistan where several young Muslim economists praised it.

Egypt attempted to use Islamic banking, beginning in 1963 by forming a savings bank that was based on profit-sharing. This experiment lasted until 1967, at which point nine banks were created within Egypt.

Over the years, more and more banks opened up that worked on the concept of Islamic finance. One such bank was the Dubai Islamic Bank, which opened in 1975.

Currently, Islamic banking, or Islamic finance, is growing at roughly 10 to 15 per cent per year, and there is no sign that it is going to be slowing down. Currently, Islamic banks have more than 300 banks spread across 51 countries, including the United States. They also have an addition 250 mutual funds that work on Islamic finance concepts. Roughly $822 billion in assets are managed by Islamic finance concepts. This is about .5 per cent of the world’s total assets. Islamic finance is also the fastest growing segment of global finance in the world, and sales of Islamic bonds have risen by 24 per cent, to $25 billion, by this year alone.

According to Standard & Poor’s Rating Services, the potential market of $4 trillion existed for Islamic financing and banking.

The countries of Iran, Saudi Arabia and Malaysia are the biggest Islamic bank compliant countries on Earth, with Iranian banks accounting for 40 per cent of the total assets of the world’s top 100 Islamic banks. The Bank Melli Iran had the most assets with $45.5 billion, followed by Al Rajhi in Saudi Arabia with $39.7 billion. Iran also has the most Islamic finance assets valued at roughy $235.3 billion.

So, how does Islamic banking work if there is no interest? Since that is where many banks make most of their money. In an Islamic mortgage, instead of loaning money to the homebuyer to buy the house, a bank will buy the item itself from the home seller, and then re-sell it to the buyer at a profit. The buyer can pay in installments, however the bank cannot make profit explicitly, otherwise it will face fines, so it cannot have penalties for late payment. In order to make sure that the buyer does not default on the transaction, a Murabaha arrangement is made, which is similar to real estate leasing.

Some banks will use a Musharaka al-Mutanaqisa approach, which involves a floating rate which works like a rental. The bank and individual borrowing will form a partnership, with both putting in capital and agreeing on a percentage for buying the property. The partnership rents out the property to the borrower, and the borrower is charged rent. While this is happening, the borrower slowly buys the bank’s portion of the property from them over agreed payments over a set period of time until the partnership ends.

As would be expected, Islamic banking does not just forbid the use of interest, but also works on other principles of Islam. Islamic banking restricts transactions that involve pork, gambling and alcohol as well. This makes it a form of ethical investing, which makes it very popular with some Western World investors. Islamic finance and banking is sometimes called a full-reserve banking method, where banks have a 100 per cent reserve ratio, at least in theory.

Islamic finance is a unique concept that is very popular in the Muslim world, and could become popular here as more banks use the methods of Islamic banking to help people get loans that are easier to repay, meaning the risk of default is less.

More A Dawn Articles:

How to Motivate Yourself

Canada ETFs Begin Charging HST

The Canada Small Business Financing Program

Where To Be In Canada During The Recession? The West!

A Dawn Journal June 2010 Archive

What is Globalization?

What is a Mortgage Default?

What Is Time Value Of Money?

How To Invest In China Through ETFs

Economics 101 – India

How Compound Interest Works

Compound Interest 101

Mutual Fund Fees and Expenses

Saving For Your Retirement

Different Types Of Mutual Funds

Quantitative Easing (QE)

When someone hears the words “quantitative easing”, they can be forgiven for not knowing exactly what that this financial concept is. After all, it is a complex concept that many people, people outside the financial industry, simply do not understand.

Quantitative easing is a monetary policy that is used by central banks as a way to increase the overall supply of money, which allows them to increase the reserves of the banking system. This is typically done through the purchasing of central government bonds, in order to stabilize, and/or prices and thereby lower long-term interest rates. When normal methods at controlling the money supply have failed, this method is typically used.

As for how the policy is implemented, quantitative easing is done in the following method:

1. A central bank will credit its own account with money it creates.
2. The central bank then purchases financial assets which can include agency debt, mortgage-backed securities, corporate bonds and government bonds. This gives the bank an excess of reserves that allows them to create new money, thereby creating economic stimulation.

Obviously, there are risks associated with quantitative easing. Sometimes the policy is not effective enough if banks don’t use the additional money they have made in order to increase capital reserves, which then increases the risk of the bank defaulting on its loan portfolio, which can cause many more problems down the road. Another problem is that quantitative easing can create an excess of inflation, more than is desired, and even lead to hyperinflation.

The Bank of Japan used quantitative easing in order to fight against the deflation of the domestic currency in Japan. Recently, thanks to the massive economic crisis that has gripped the world, the United States Federal Reserve has used quantitative easing to fight the effects of the recession. The European Central Bank has also used 12-month long-term refinancing operations through the process of expanding on assets that the banks can then use as collateral.

The reason that it failed with Japan is because the Bank of Japan maintained short-term interest rates at close to zero values for several years. Then, using quantitative easing, they flooded banks with an excess of money in order to influence private lending. This then caused large stocks of excess money, which then create a small risk of money shortfalls.

Japan actually created quantitative easing, with the Bank of Japan adopting the policy on March 19, 2001. However, the earliest written record of the term dates back to Richard Werner, a professor of international banking at the School of Management in the University of Southampton, when he warned of the coming collapse of the Japanese economic banking system.

So, that essentially sums up quantitative easing and what it is. While it may still be difficult to understand, you at least have a basic understanding of what this unique financial tool is and the effect that it can have on your life. During this financial crisis, it is clear that quantitative easing may be the one way out of it for many central banks.

More A Dawn Articles:

What Is Fiscal Stimulus?

Real Estate in Portugal

Rabat: The Garden City

How to Strengthen Your Willpower

The Canada Small Business Financing Program

What To Expect From Your Lawyer When Buying A Condo?

Fiscal Stimulus

Right now there is a lot of talk about how the government is trying to get the economy moving through the use of stimulus packages. Often, many wonder about just how effective a stimulus package is and whether or not fiscal stimulus is actually something that should be used. The problem is that many people do not understand what fiscal stimulus is, so to help, here is a rundown to get you up to speed.

Fiscal policy is essentially fiscal stimulus and it involves the use of government spending and revenue collection to help influence the economy, usually to restart it and get it moving again during a recession. Government expenditures, known as fiscal stimulus, helps to distribute income, allocate resources, and aggregate the demand and level of economic activity.

Many economists actually doubt just how effective a fiscal stimulus actually is though. The reason is that some economists feel that fiscal stimulus will cause crowding out. What this means is that government borrowing will lead to higher interest rates, which then will offset the stimulus and its impact on spending. When the government is running into a deficit with its budget, then the government gets its money from issuing government bonds, which is a form of borrowing from the public. The government can also borrow from overseas or monetize the debt. When the government funds a deficit with government bonds, the borrowing itself creates a higher demand for credit, which then causes interest rates to increase. This in turn creates a lower demand for goods and services, which completely goes against the point of the stimulus package itself.

In the United States, the most famous example of fiscal stimulus is the American Recovery and Reinvestment Act of 2009. The point of this stimulus was to create jobs and promote consumer investing and spending through the recession. This goes along with the basis of a fiscal stimulus, which is the government running a deficit in order to improve spending with the consumers through a recession. Many economists felt this was the wrong path to take but the Federal Reserve had already cut interest rates to zero, which thereby reduced the number of policy options open to the government. The flow of cash within the government was also stagnant, which made things difficult and the government argued that a stimulus was the only option within these conditions. This fiscal stimulus package was worth $787 billion and included the expansion of unemployment benefits, social welfare services, increased spending in education, the energy sector, infrastructure and health care. It also featured tax incentives for consumers and companies to help jump-start the economy.

It will be awhile before we know for sure if the stimulus package worked or not, but as for now, the concept of fiscal stimulus appears to be the best bet for many industrialized countries around the world who are trying to improve their economies and get out of the worst recession since the Great Depression. Now you know what a fiscal stimulus is, which will help you understand how it works and how it affects you better.

More A Dawn Articles:

What Is Rent To Own?

Real Estate In Cyprus

How to Strengthen Your Willpower

Guaranteed Income Supplement (GIS)

How To Lower Your Credit Card Interest Rate

The Canada Small Business Financing Program

A Dawn Journal May 2010 Archive

What Are Mutual Funds? Advantages and Disadvantages of Mutual Funds

The Equal-Weight ETFs from BMO

BMO’s 8 New ETFs

Reverse Mortgage, Home Income Plan, or Equity Release Schemes

RRSP or Registered Retirement Savings Plan

How To Avoid Extra Costs On Your Mortgage

What Is Micro and Macro Economics?

A Brief History of Gold

How to Raise Financially Responsible Kids

What Is The International Monetary Fund (IMF)

Opportunity Cost

There are a lot of complicated concepts in economics, and while some are easier than others, all of them are important to understand. Economics is a diverse field with many things at play, and if you want to invest, or just save money, you should at least have a basic understanding. This brings us to opportunity cost, something that you may not have heard of, but which you deal with on a regular basis.

Opportunity cost is the cost that is associated with the next-best choice available to you based on two, or more mutually exclusive choices. It is a very important factor in economics and it helps blend the relationship between scarcity and choice together. Thanks to opportunity cost, resources that are scarce and difficult to obtain, are therefore used more efficiently. This also means that opportunity cost goes well beyond economies and financial costs, and into other areas including pleasure, lost time, utility and more.

First created by John Stuart Mill in the 19^th century, opportunity cost has become a cornerstone of economics around the world, helping to shape the world we currently live in. Now, opportunity cost may seem rather foreign, and slightly difficult to comprehend, but to help you here are some examples that illustrate opportunity cost.

• Someone takes $50,000 and puts it into a stock, while the person makes money if the stock goes up; they have lost the money that would have come from leaving the $50,000 within the bank, where they would have collected interest on it. Therefore, the opportunity cost to that person, who chose to invest in stocks than leave it in the bank, is the interest they would have received on their savings.
• An individual walks into a store and must decide between spending $20 on a video game or on a new pair of jeans. If the person buys the jeans, the opportunity cost is the video game, while conversely if they buy the video game the opportunity cost is the jeans.

Opportunity cost is not just about material or monetary items; it is about what has more value to a person. For example if a person can afford to go see one movie, and must choose between an action and comedy, they must assess which will give them more enjoyment. If they choose the action movie, then the opportunity cost is the comedy, while if they choose the comedy, the opportunity cost is the action movie.

As you can see, opportunity cost is something you use on a regular basis throughout your life. When you are choosing between what TV shows to watch, what book to buy, which turn to make on the street and more, you are using opportunity cost. Understanding opportunity cost, especially in finances, will then allow you to get the most out of your decisions and help you earn more money, or save it based on the decision you make. Opportunity cost is something you may not have heard of, but it is something you use every day of your life.

More A Dawn Articles:

Real Estate In Sydney

Real Estate In Melbourne

Canada Pension Plan or CPP

Some Facts About China’s Economy

The Most Successful Entrepreneurs in History

November 2007 Archive

Still Paying Banking Fees? – Revisited

Aerial View Of Toronto Downtown From The CN Tower

Easy Green

October 2007 Monthly Highlights

An Aerial Shot of the Toronto HTO Park

A Brief History of Globalization

A concept that is becoming more and more important in the 21^st century is globalization. Globalization is something that has been going on for thousands of years, but it is only now we are truly seeing the effects of a global society, rather than one based on separate countries competing for resources. Globalization is the process where economies, societies and various cultures are connected through various networks that include trade, communication and transportation across the planet. Economic globalization follows along these same lines, in which economies become connected through investment, migration, trade and flows of capital.

Globalization History

Globalization as we know it goes back to around the Hellenistic Age, when urban centers were the center of Greek culture and held sway from Spain to India with its culture. As time went on, various other empires helped push globalization closer and closer to a reality. The Roman Empire, Han Dynasty and Parthian Empire are all given as examples of empires that were globalized based on the world that that time. A good example of this is the fact that 300 Greek ships a year sailed between Rome and India, sending 300,000 tons of goods.

When Islam came into being, globalization took another step forward as Jewish and Muslim traders created sustained economies that spread across Europe, Africa and the Middle East. Ideas, technology and food all began to be traded and spread over vast distances. The Mongol Empire continued this when they had an empire that stretched from Korea to Europe, helping to spread technologies across Europe and Asia. Thanks to the Mongol Empire, trade along the Silk Road greatly increased, leading to Marco Polo to make his famous journey to China.

Once the Age of Discovery began, globalization moved into the New World as European powers like Portugal, Spain, France and England began to take advantage of the glut of resources North and South America provided. When the Industrial Revolution began in the 18^th and 19^th centuries, globalization took another step forward, leading to the world as we know it. Vast trade in resources helped connect countries and cultures across the planet.

Following the Second World War, politicians began to break down borders that hampered trade so that interdependence and prosperity could increase and therefore prevent a future global war. Organizations like The World Bank and the International Monetary Fund, along with free trade, helped to spread wealth and capital across the world. Some of the ways that economists have achieved this global trade concept through globalization include:

• The creation of free trade areas and the elimination of tariffs.
• The reduction of transportation costs.
• The elimination of capital controls.
• Creating subsidies for global corporations.

Globalization Effects

Globalization has had many different effects across the planet. These are both good and bad. A good example of the bad effects includes sweatshops and the loss of jobs as companies go to cheap countries where labour laws are relaxed. However, in terms of good effects, we have the following:

• Foreign products have spread across the planet with the movement of goods through international trade. Since 1955, international trade of goods has increased 100 times from $95 billion to $12 trillion. A good example of this is the fact that China’s trade with Africa rose by seven-fold between 2000 and 2007.
• Roughly $1.5 trillion is traded in national currencies on a daily basis thanks to globalization and the emergence of worldwide financial markets.
• Thanks to globalization, the United States has enjoyed great power since the 20^th century because of its massive amount of trade. China is now catching up on the United States and will soon become the leading world power.
• Information is traded through globalization thanks the Internet, television and other mediums like telephone and radio.
• Globalization has helped to harmonize languages. The most widely spoken language on Earth is Mandarin with 845 million speakers, while Spanish and English come in second and third with 329 million and 328 million speakers. Roughly 35 percent of all mail is in English, while 50 percent of the internet traffic is in English and 40 percent of radio programs are in English.
• Globalization has led to greater travel and tourism, with as many as 500000 people on planes at any one time and 922 million international tourists moving about each year. Immigration has also increased and multiculturalism has become extremely common throughout the world.

Globalization is happening all around us and many do not even realize that they are experiencing it every day. A good example of this follows:

A man wakes up in the morning and dresses in clothes that were made in Southeast Asia and China. He gets coffee from his kitchen, with the coffee coming from Africa and the coffee cup coming from Europe. He has a breakfast made up of fruit from South America and milk from Canada. He gets in his car, which was made in Japan, and fills it up with gas that was originally oil extracted from the Middle East. As he gets to his office and uses furniture made in Sweden and electronics made in Asia, he surfs the net, hitting websites located in 15 different countries.

This is just a brief example of how one person, in the first few hours of a day, can be using items that come from all over the world. While globalization has received a lot of bad press, the good it has done is unmistakable. It has spread prosperity across the planet and helped get people out of poverty. Less than 12 percent of the world lives in extreme poverty now, down from over 40 percent 30 years ago. In addition, more people have food, more people are making money and more people can live the lives that they want. There are downsides, including the effect on the environment due to global trade, but overall globalization is leading to a better world and we should be happy we live in a world where the world is interconnected.

More A Dawn Articles:

Real Estate in Australia

What is a Mortgage Default?

What Is Time Value Of Money?

How to Buy Property in Australia

Do You Know What You Can Compost?

How to Create a Bucket List to Improve Your Life

September 2007 Archive

Toronto’s Waterfront

CI Financial’s Unsolicited, Hostile Bid

Save 1% On Everything

Build Your DreamWorld And Get A Free Entry To Win $25,000

How to Get $100 a Month Housing Allowance

Green Traffic Light

Free Online Storage

Best Home Phone Deals

Through My Eyes

August 2007 Monthly Highlights

Understanding Time Value of Money

Everyone wants to know how much their money is going to be worth down the road. Not only that, knowing how much money you may have will help you save better and make more money. Over the course of this article, I will cover four important concepts. They are:

1. Time Value
2. Present Value
3. Net Present Value
4. Future Value

All of these concepts will center on the value of money. We all know that money is valuable, but what about the time value of it? What is it worth now, how much is it truly worth now, what is its future value? All of these need to be understood if you are going to get the most out of your money.

Time Value

The time value of money is the value that is given to the amount of interest earned by the money over a certain period of time. That means that if the money earns a few dollars interest, then its time value will be based on how much value will be associated with the money and the interest. Here is a simple example to help show what we mean:

Let’s say you have 100 dollars right now and you put it away in an investment that earns you 10 percent over the next year. That means that your original 100 dollars is going to be worth 110 dollars in about a year. So, 100 dollars paid out now, or the 110 dollars paid out in one year will have the same value to the recipient who assumes the interest. However, using the time value of money, we know that the future value of the money is going to be 110 dollars. What makes this important is it allows a person to determine their future annual incomes. That way, annual incomes are discounted and added together to create a lump-sum that is the present value of a total income stream.

Present Value

The present value of money is the value of money on a given date for a future payment, discounted to reflect the time value of money and other factors. In economics, present value calculations are widely used, as well as in business.

If you are given the choice between getting $100 now, or $100 in one year, you will probably take the $100 now because that gives you money immediately. This is where Time Preference comes in. For example, if the $100 is worth $70 in one year, then the present value of the $100 one year in the future is $70. When you have money you have two options, you can save it or spend it. The benefit from saving money is that later on it will incur interest and that will give you more money down the road.

When money is evaluated for its present value in the future, it is called capitalization. So, let’s look at an example.

If you have the choice between $100 today and $100 in one year, you will probably choose the money now but if the money in a year earns 10 percent interest, then you can have $110 in one year, more than you would get now. The present value of the money at the future date is going to be $110.

Net Present Value

The net present value of a time series of money, both incoming and outgoing, is defined by the present values of the individual cash flows. Net Present Value is a central tool in discounted cash-flow and is used when determining the time value of money for long-term projects, such as budgeting within a company. By measuring the excess or shortfall of cash flows, in present terms, it is possible for companies to make good financial decisions.

Companies will use Net Present Value to determine if an investment or project is going to add value to the company. By using the calculations for Net Present Value, it is possible to determine the NPV and therefore, the value for the company as follows:

• If the NPV is greater than zero, the investment would add money to the company and therefore the project should be accepted.
• If the NPV is less than zero, then the investment will take value away from the firm and the project should be rejected.
• If the NPV is equal to zero, then the investment will neither take money nor give money to the company. This means that decisions to accept or reject the project, should be based on other factors.

Future Value

The future value of money is how much a given sum of money will be worth at a specific time given the interest rate and the rate of return. The value does not include things like corrections for inflation.

Here is a brief example to illustrate future value of money. If you are given $100 today, it is worth $100, however in five years it will not be worth $100 because of the changing value of money. You can put the money into the bank and it will either grow or fall in value depending on interest. In addition, if you buy something today for $100, you may not be able to buy that same item for $100 because of inflation increasing the purchase price. Inflation can grow by about half a percent to one percent per year, and that will mean that the item will cost as much as five dollars more in five years.  As a result, economists will evaluate the true value of the money over a given period of time based on future value calculations. Companies and economists will look at the real interest rate to determine the purchasing power change over a period of time.

More A. Dawn Articles:

Compound Interest 101

Real Estate in Australia

How to Buy Property in Australia

How To Invest In China Through ETFs

The Canada Pension Plan (CPP) Faces Depletion?

Top Three Countries in Caribbean to Buy Real Estate

July 2007 Archive

Save For Retirement

Money Saving Tips – Part 5

Money Saving Tips – Part 4

Money Saving Tips – Part 3

Money Saving Tips – Part 2

Money Saving Tips – Part 1

The World Bank

One of the most important financial institutions in the world, if not the most important, is the World Bank. The World Bank is an international financial institution that provides leveraged loans to developing countries to help fund capital programs. Through the World Bank, the expressed goal of reducing poverty is worked towards.

Many people confuse the World Bank with the World Bank Group. The World Bank is made up of the International Bank for Reconstruction and Development and the International Development Association, while the World Bank Group is made up of those two organizations, as well as the International Finance Corporation, Multilateral Investment Guarantee Agency and the International Center for Settlement of Investment Disputes.

The World Bank was created in 1944 at the Bretton Woods Conference, which was the same conference where the International Monetary Fund was created. Like the IMF, the World Bank is headquartered in the United States. One interesting note is that while the IMF is traditionally led by a European, the World Bank by custom is always led by an American. The first country to be selected for World Bank aid was France, while Poland and Chile were rejected. The first loan was for $987 million, roughly half of what was originally requested and this was under strict conditions. The World Bank then monitored the use of these funds and it was required by the French government to provide a balanced budget and a plan for repayment to the World Bank. In addition, the United States required that the French government remove any communist elements within its cabinet in order to qualify for the loan. France, which had been decimated by the Second World War, complied.

The World Bank has set forward five factors that are necessary for economic growth within a country, which allows them to help countries improve their financial standing and the standard of living of the country’s citizens. These factors are:

1. Build capacity to strengthen governments.
2. Create infrastructure to implement justice systems that aid business and protect the rights of individuals and their property.
3. Develop financial systems that are strong and can handle tough economic times through concepts like corporate ventures and micro-credit.
4. Combat corruption by helping countries eradicate it within their borders.
5. Research and train countries and their citizens, while providing the opportunity for citizens of these countries to get an education.

The World Bank has decided that it would try and reach some very ambition goals by 2015 in order to help make the world a better place. These goals have helped to improve the image of the World Bank from just an international bank, into an organization that is dedicated to making the world a better place. The goals set out by the World Bank for 2015 are:

• Eradicate Extreme Poverty/Hunger
• Universal Primary Education
• Promote Gender Equality
• Reduce Child Mortality
• Improve Maternal Health
• Combat the Spread of Diseases
• Ensure Environmental Sustainability
• Develop Global Partnership

Thanks to the World Bank, things are improving on many fronts.

These policies and goals are being pushed by the main voting powers of the World Bank. In 2010, the World Bank revised its voting system to help give developing countries more of a say in the decisions of the organization. Currently the voting powers of the World Bank are split as follows:

1. United States:  15.85 percent
2. Japan:  6.84 percent
3. China:   4.42 percent
4. Germany:  4.00 percent
5. France:  3.75 percent
6. United Kingdom: 3.75 percent
7. Other members: 61.39 percent

Under the reforms in 2010, countries like Brazil, India, South Korea and Mexico saw their voting power increase. Many developed countries lost voting power while Russia did not see a change in its voting power.

More Economy 101 Posts:

What Is Inflation?

What Is A Recession

Economy 101 Archive

Canada Personal Finance Website

What Is GDP (Gross Domestic Product)?

What Is The International Monetary Fund (IMF)

Difference Between Macro and Micro Economics

In our day-to-day lives, the news will often mention the concept of microeconomics and macroeconomics. These two schools of economics are not as complicated as some people believe, but the concepts are extremely important for the economy of the planet. So, why not learn about microeconomics and macroeconomics? Here are some things for you to learn about these interesting economic policies. Before we start, here are some main ingredients of Micro and Macro Economics – Microeconomics: The Law of Supply, The Law of Demand, Opportunity Cost etc. Macroeconomics: Monetary policy, Fiscal Policy, Gross Domestic Product, Consumer Price Index, Unemployment, Inflation etc .

Microeconomics

Microeconomics is a branch of economics in which there is the study of how the individual parts of the economy, made up of households and firms, make decisions in order to allocate a limited amount of resources. These decisions are usually done in markets where goods and services are being bought and sold.  Microeconomics examines how all these decisions on the individual part have an impact on the supply and demand of goods, which in turn determine price and which itself determines the supply and demand of these goods and services.

Microeconomics is in contrast of macroeconomics, which looks at the total of economic activity rather than the individual parts of the economy. Microeconomics is not just about how individual parts affect the economy, but it is also about the effects of economic policies like taxation on the economy. Microeconomics also has the goal of analyzing market mechanisms in order to establish prices among goods and services and to allocate limited resources through alternative uses. Market failure is also analyzed through microeconomics, which is when markets do not produce efficient results, which allows microeconomics to describe the conditions that are needed to create the concept of perfect competition. Some places of study for microeconomics include:

• General equilibrium
• Asymmetric information
• Uncertainty choices
• Game theory
• Elasticity of products

Under microeconomics, there are four categories in which a firm’s profit may be considered since it is assumed that all firms are following a decision making process that is rational and will produce the maximum profit output.

1. When a firm has an average total cost that is less than the price of each additional product, then the firm is said to be making an economic profit. In this, the economic profit is equal to the quantity of the output when it is multiplied by the difference between the total cost and the price.
2. When the firm’s economic profit is equal to zero, which occurs when the average total cost equals the price of the product or service, then the firm is making a normal profit.
3. If the price is between the average total cost and the average variable cost, then the firm is in loss-minimizing condition. The firm produces, but if the firm stops producing then its loss would be larger. Firms continue production to offset the variable cost.
4. When the price is below the average variable cost, the firm is in the shutdown condition. Losses are therefore minimized by not producing anything. The reason for this is that production would not generate any returns that would be large enough to offset the fixed costs and a portion of the variable cost.

Macroeconomics

In contrast to microeconomics, macroeconomics deals with the performance, behaviour, decision-making and structure of the entire economy. This can be the national economy, the regional economy, or even the world economy. Typically, macroeconomics will look at GDP, unemployment rates and price indexes to determine how the economy is functioning. Macroeconomists will create models as well that look at the relationships between:

1. National income
2. Output
3. Consumption
4. Inflation
5. Unemployment
6. Savings
7. International trade
8. International finance
9. Investments

Macroeconomics, by definition, is very broad in its scope and study, but there are two areas where macroeconomists will research. These are the attempt to understand the causes and consequences of short-run fluctuations within a business cycle and the attempt to understand the determinants of the increases in national income.

Macroeconomics will help prevent depressions and recessions by allowing governments to make adjustments through changes within the macroeconomic policies. These policies are typically the fiscal policy and monetary policy of the country.

Within macroeconomics, there are two primary schools of thought; Keynesian tradition and neoclassical tradition.

• Keynesian economics is a theory that was essentially created by the economist John Maynard Keynes. Through this policy, it is believed that fluctuations within the business cycle can be reduced through fiscal policies where the government spends less or more, and the monetary policy. Early Keynesian economist supporters wanted the regular use of policy to stabilize the economy of capitalist countries. Currently, in what is called Post-Keynesian Economics, there is emphasize on the importance of demand in the long run, and the role of uncertainty, preference and liquidity of the economy.
• Neoclassical tradition challenges Keynesian tradition to ground the theory of macroeconomics in microeconomics. With this type of macroeconomics, the main policy difference is the increased focus that is put on monetary policy, like the money supply of the country and the interest rates. It was during the 1970s that this school of thought emerged.

There is one more underused form of macroeconomics school of thoughts is monetarism, which was created by Milton Friedman which says that inflation is always a monetary phenomenon. It does not include the concept of fiscal policy as it is the belief of supporters of monetarism that fiscal policy crowds out the private sector. Monetarism does not combat inflation or deflation through active demand management.

Macroeconomics and microeconomics help to influence the economy of countries around the world and many economists are not only divided between the two concepts, but the schools of thoughts within each. However, whether you understand macroeconomics and microeconomics, or you have trouble with the concept, both policies have a big impact on our lives and the economy of countries like the United States.

While there are many things to understand within economics, but if you have to choose two things to research and learn about it should be macroeconomics and microeconomics.

More Economy 101 Posts:

What Is Inflation?

What Is A Recession

Economy 101 Archive

Monetary Policy and Fiscal Policy

Canada Personal Finance Website

What Is GDP (Gross Domestic Product)?

How the Loonie Affects the Canadian Economy

The International Monetary Fund (IMF)

Whether you know it or not, there is an organization that has a huge impact on your life and while you probably have heard of it, you may not truly realize all that the International Monetary Fund (IMF) does for you. The IMF is an international organization that looks over the global financial system by applying the policies of macroeconomics to the countries that are members of the Fund. This includes overseeing the exchange rates of countries, as well as the balance of payments within these countries.

The IMF was formed with the objective of stabilizing international exchange rate, while also helping countries develop financially through liberalized economic policies as well as providing loans, aid and restructuring finances. In addition, the IMF offers leveraged loans to poorer countries in order to help them out.

Headquartered out of Washington D.C., the IMF was formed in July of 1944 by the 45 original members during the United Nations Monetary and Financial Conference at the Mount Washington Hotel in New Hampshire. Everything was officially organized on December 27, 1945 when the first 29 countries signed the Articles of Agreement. During the Second World War, the world’s finances were in a chaotic state and it was the purpose of the IMF to help aid in the reconstruction of the international payment system of the world, as well as stabilize the exchange rates that were fluctuating widely at the time. At the time, countries would contribute into a pool that they could temporarily borrow from.

The IMF currently has 186 countries in its membership which work together to create global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, while reducing poverty, in the words of the IMF itself.

All UN member states, with the exception of Taiwan, North Korea, Cuba, Andorra, Monaco, Liechtenstein, Tuvalu and Nauru, are members of the IMF.

All of these member states are represented by a 24-member Executive Board. There are five Executive Directors, which are appointed by the five members that have the largest quotas. The rest are made of Executive Directors that have been elected by the remaining members. All the members of the IMF then appoint a Governor to the IMF Board of Governors.

The influence of the IMF has increased greatly over the global economy as the numbers of members have increased over the years. Many cite the IMF as a contributing factor to the political independence of many developing countries, as well as helping usher in the end of the Cold War with the collapse of the Soviet Union.

Of course, things have not always been rosy for the IMF. In 2008, when the financial crisis was just beginning, the IMF decided to sell some of its gold reserves. In addition, the IMF has decided to implement a new framework for the organization to help deal with a $400 million budget deficit. By 2011, it is estimated that there will be roughly $100 million in spending cuts and the removal of 380 staff positions in order to help save money.

This was not the end to the changes implemented within the IMF. At the 2009 G-20 London Summit, the IMF decided it would need more financial resources to meet the needs of its member countries as a result of the huge financial toll the global financial crisis was taking. To help, the G-20 leaders, who represent the 20 largest economies on Earth, pledged to increase the supplemental cash to the IMF from $50 billion to $500 billion, while allocating an additional $250 billion to member countries.

Through thick and thin, boom and bust, financial turmoil and recessions, the IMF has been a constant that, in various ways, is trying to make the world a better place. The lack of wars between its member countries on the whole seems to show that it has been a success at this.

IMF Website Link: The International Monetary Fund (IMF)

Some hand-picked related and non-related posts:

Real Estate In Phuket

Cross Border Shopping Tips

India in The 21st Century

Why Optimism Is Important?

Monetary Policy and Fiscal Policy

Phuket – The Pearl of The Andaman

Foreign Property Mortgages for Canadians

How To Come Up With Great Domain Names

Is A Dawn Journal The Best Personal Finance Blog?

Forecasting And Multiple Scenario Planning And How To Use Them

Toronto Real Estate – A World Class City Is Still Surprisingly Affordable

What is the difference between monetary and fiscal policy?

Two of the most important parts of any country’s economics are their monetary and fiscal policies. Many people assume that these two policies are one and the same, but this is not the case. These policies are two different entities that affect a country’s economics in different ways.

Monetary Policy

The monetary policy of a country is the process by which a government or central bank supply money to the populace, thereby affecting the availability of money as well as the cost of money and the interest rate associated with it. This is done to reach a certain set of objectives to help the economy grow, as well as remain stable in difficult financial times. Economists will also refer to monetary policy as being the expansionary or contractionary policy of the country. When it is referred to as the expansionary policy, is when the total money supply of the economy is increasing, while contractionary policy is the opposite, where money is decreasing. These two policies within the monetary policy are also used at different times. When there is a recession, interest rates are lowered to combat unemployment through the expansionary policy. However, if the economy is suffering from high inflation, then interest rates are raised through a contractionary policy.

Interest rates are highly important to the monetary policy of the country and there is a distinct relationship between monetary policy and interest rates. Through the monetary policy, the interest rates of the country are tied in with how much money is supplied and how much is being borrowed. Through this relationship, it is possible to influence the inflation, economic growth, exchange rates and even unemployment of the country.

Nearly all industrialized and developed nations operate their monetary policy through specially created institutions. Examples of these institutions include the European Central Bank for the EU, the Reserve Bank of India, The Federal Reserve System of the United States, the Bank of Canada, the Bank of Japan, the Reserve Bank of Australia and the Bank of England. These institutions are called central banks and they have the distinct task of ensuring the financial system of the country is operating properly.

The most often used tool of monetary policy is open market operations. With this the government can manage the money supply of the country by buying and selling treasury bills, foreign currencies and company bonds. Other tools used by central banks to manage monetary policy include discount window lending, fractional deposit lending, moral suasion and open mouth operations.

Without central banks and a monetary policy, the economy of a country would be highly unpredictable. There would be no way to manage money and recessions could easily turn into depressions and inflation could run out of control. Examples of countries with poor monetary policies include Zimbabwe, which has seen its inflation rate reach unprecedented levels. Whenever a country hits a rough patch, or needs to do some work to keep its economy moving forward, the citizens should be happy they have a good monetary policy in place.

Fiscal Policy

Fiscal policy is not monetary policy, and it is important to make this distinction. A fiscal policy is the use of government expenses and revenue collection in order to influence the economy. This differs from monetary policy, which is used to stabilize an economy through interest rates and money supply.

Fiscal policy uses expenditures of the government and taxes in order to influence the economy. Through the changing of the level of taxation, it is possible for the government to improve the demand and level of economic activity, while also allocating resources and ensuring that income is distributed properly. As a result, the fiscal policy of a country can refer to the effect of the outcome of a budget on the activity of the economy. With fiscal policy, there are three different methods that can be used; neutral, expansionary and contractionary.

With a neutral stance, the budget is balanced, where the spending of the government is equal to the tax revenue that comes in. Therefore, the government gets all the money it needs from taxes and the budget outcome has no effect on the economy activity level of the country.

With an expansionary stance, government spending is greater than the tax revenue coming in. This is done by either lowering the taxes of the country, or by increasing the expenditures of the country while leaving taxation the same. This creates a budget deficit in most cases.

With a contractionary fiscal policy, taxation is greater than government spending. This is done through increasing taxation and leaving spending the same, or by reducing spending. This leads to a surplus for the government in most cases.

There are several ways that a fiscal policy will be funded, not including the largest way which is through taxation. These methods include:

1. Seigniorage, which is printing money.
2. Borrowing money from the population.
3. Using fiscal reserves.
4. Selling assets like land.

When a deficit needs to be funded through fiscal policy, it is usually done through the issuing of bonds, bills and securities. Since these pay interest, the government is able to collect money on them for a fixed period of time. However, when the government is borrowing money and cannot afford the fiscal payments, it will go into default on its foreign loans.

A fiscal surplus can be saved for future use, in which case it is usually invested in currency or other financial investments until it is needed. When there is an economic slump and taxation as well as income falls, these reserves can then be used to continue funding expenditures at the same rate as before, without having to worry about taking on more debt.

The fiscal policy is very important and has been used several times in the past to help countries get out of recessions, while also helping countries continue operating at pre-recession expenditure levels. Fiscal policies, combined with monetary policies, keep a country’s economy moving forward and benefit everyone in the long run.

More Economy 101 Posts:

What Is Inflation?

What Is A Recession

Economy 101 Archive

Canada Personal Finance Website

What Is GDP (Gross Domestic Product)?

How the Loonie Affects the Canadian Economy