<< Chapter < Page Chapter >> Page >

Getting additional education and saving money early in life obviously will not make you rich overnight. Additional education typically means putting off earning income and living as a student for more years. Saving money often requires choices like driving an older or less expensive car, living in a smaller apartment or buying a smaller house, and making other day-to-day sacrifices. For most people, the tradeoffs for achieving substantial personal wealth will require effort, patience, and sacrifice.

How capital markets transform financial flows

Financial capital markets have the power to repackage money as it moves from those who supply financial capital to those who demand it. Banks accept checking account deposits and turn them into long-term loans to companies. Individual firms sell shares of stock and issue bonds to raise capital. Firms make and sell an astonishing array of goods and services, but an investor can receive a return on the company’s decisions by buying stock in that company. Stocks and bonds are sold and resold by financial investors to one another. Venture capitalists and angel investors search for promising small companies. Mutual funds combine the stocks and bonds—and thus, indirectly, the products and investments—of many different companies.

Visit this website to read an article about how austerity can work.

In this chapter, we discussed the basic mechanisms of financial markets. (A more advanced course in economics or finance will consider more sophisticated tools.) The fundamentals of those financial capital markets remain the same: Firms are trying to raise financial capital and households are looking for a desirable combination of rate of return, risk, and liquidity. Financial markets are society’s mechanisms for bringing together these forces of demand and supply.

The housing bubble and the financial crisis of 2007

The housing boom and bust in the United States, and the resulting multi-trillion-dollar decline in home equity, started with the fall of home prices starting in 2007. As home values fell, many home prices fell below the amount owed on the mortgage and owners stopped paying and defaulted on their loan. Banks found that their assets (loans) became worthless. Many financial institutions around the world had invested in mortgage-backed securities, or had purchased insurance on mortgage-backed securities. When housing prices collapsed, the value of those financial assets collapsed as well. The asset side of the banks’ balance sheets dropped, causing bank failures and bank runs. Around the globe, financial institutions were bankrupted or nearly so. The result was a large decrease in lending and borrowing, referred to as a freezing up of available credit. When credit dries up, the economy is on its knees. The crisis was not limited to the United States. Iceland, Ireland, the United Kingdom, Spain, Portugal, and Greece all had similar housing boom and bust cycles, and similar credit freezes.

If businesses cannot access financial capital, they cannot make physical capital investments. Those investments ultimately lead to job creation. So when credit dried up, businesses invested less, and they ultimately laid off millions of workers. This caused incomes to drop, which caused demand to drop. In turn businesses sold less, so they laid off more workers. Compounding these events, as economic conditions worsened, financial institutions were even less likely to make loans.

To make matters even worse, as businesses sold less, their expected future profit decreased, and this led to a drop in stock prices. Combining all these effects led to major decreases in incomes, demand, consumption, and employment, and to the Great Recession, which in the United States officially lasted from December 2007 to June 2009. During this time, the unemployment rate rose from 5% to a peak of 10.1%. Four years after the recession officially ended, unemployment was still stubbornly high, at 7.6%, and 11.8 million people were still unemployed.

As the world’s leading consumer, if the United States goes into recession, it usually drags other countries down with it. The Great Recession was no exception. With few exceptions, U.S. trading partners also entered into recessions of their own, of varying lengths, or suffered slower economic growth. Like the United States, many European countries also gave direct financial assistance, so-called bailouts, to the institutions that make up their financial markets. There was good reason to do this. Financial markets bridge the gap between demanders and suppliers of financial capital. These institutions and markets need to function in order for an economy to invest in new financial capital.

However, much of this bailout money was borrowed, and this borrowed money contributed to another crisis in Europe. Because of the impact on their budgets of the financial crisis and the resulting bailouts, many countries found themselves with unsustainably high deficits. They chose to undertake austerity measures, large decreases in government spending and large tax increases, in order to reduce their deficits. Greece, Ireland, Spain, and Portugal have all had to undertake relatively severe austerity measures. The ramifications of this crisis have spread; the viability of the euro has even been called into question.

Key concepts and summary

It is extremely difficult, even for financial professionals, to predict changes in future expectations and thus to choose the stocks whose price is going to rise in the future. Most Americans can accumulate considerable financial wealth if they follow two rules: complete significant additional education and training after graduating from high school and start saving money early in life.


How much money do you have to put into a bank account that pays 10% interest compounded annually to have $10,000 in ten years?

Got questions? Get instant answers now!

Many retirement funds charge an administrative fee each year equal to 0.25% on managed assets. Suppose that Alexx and Spenser each invest $5,000 in the same stock this year. Alexx invests directly and earns 5% a year. Spenser uses a retirement fund and earns 4.75%. After 30 years, how much more will Alexx have than Spenser?

Got questions? Get instant answers now!


U.S. Department of Commerce: United States Census Bureau. “Income: Table H-13. Educational Attainment of Householder—Households with Householder 25 Years Old and Over by Median and Mean Income.” http://www.census.gov/hhes/www/income/data/historical/household/.

United States Department of Labor. Bureau of Labor Statistics. 2015. “Table 9. Quartiles and Selected Deciles of Usual Weekly Earnings of Full-Time Wage and Salary Workers by Selected Characteristics, 2014 Annual Averages.” Accessed April 1, 2015. http://www.bls.gov/news.release/wkyeng.t09.htm.

Questions & Answers

elasticity and applications
sabir Reply
hello po
pls am called Nana Adjei
pls I think I can join your conversation
whats the prblm now
me to I too interested to learn economics
hi u all brothers
hi I want to learn economics
Hello to all of you I want to know in which university are you studying ?
in order to exchange different lexture and exercise for different subject of Economics
what is agricultural economics
Faraja Reply
what are the determinant of economics growth
Zuberi Reply
hey guys son marketing notice
Jude Reply
what do u mean jale?
what do you mean by what?
meaning of Money, worth and wealth, economic goods and service
Mariana Reply
money is just means of exchange denomination of wealth while wealth is the sum total of all assets held in either liquid or non liquid form, where as worth is the exchange value of an asset.
why do we study economics
We also studied economics in order to know about the human behaviour or phycology towards there needs
we study Economics to adjust unlimited human needs with the limited natural resources of the earth in order to achieve susyainabl economic development.
hi guys.....pls help me out, am confused.. should i go for accounting/accountancy or I should go for business administration?.
what is equilibrium
Daniel Reply
it is intersect point of economics line in graph, but everytime not graph
it is the intersection point of supply and demand curves
GDP is domestic gross product. refer my site amanchabukswar.wordpress.com
Aman Reply
Hi everyone
hello lovely where am I?
Good morning
hi dear bro
why does a firm continue operating at a breakeven point
Prince Reply
to retain its customers for later coming profits.
this is because the firm's revenu is covering the variable cost so the firm should continuos business
and zero profit is a normal profit which covers entrepreneur's profit along with recovering wages, interest and rent.
what economic trend can we expect after lifting of 10 year long sanctions in an national economy?
tesfie Reply
difference between change in demand and change in quantity demanded
Maurice Reply
how to change
For a demand with repect to price. change in demand refers to the shifting of demand curve, where as change in quantity demanded means movement along the given demand curve.
According to lional Robbins how did he explain economics
Raphael Reply
He defined economics as a science which studies human behavior as a relationship between ends and scares which has alternative uses.
What is economics
Nasiru Reply
why are some countries producing inside the ppf
Claire Reply
prove or disprove that balance of trade of trade deficit is a cause of an abnormal demand curve?
Chioma Reply
what's the fixed cost at output zero
Saidou Reply
fixed cost stay the same regardless of the level of output
example; electricity bill is fixed cost....but when the machinery plant is not active and perhaps so offices are locked up due to unforseen circumstances..... definitely the electric nose dive.... that is a reduction in fixed right? am just saying hope am making a point Luke?

Get the best Principles of economics course in your pocket!

Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Principles of economics' conversation and receive update notifications?