Chapter 1
Financial and Economic Concepts
1
Chapter One Objectives
2
Opportunity Costs

The highest value that is surrendered
when a decision to invest funds is made.
3
Choices Available for Funds
Table 1-1 Expected Financial Returns of Investment Opportunity
Investment Opportunity
Expected Annual Return (%)
Purchase stock
11
Purchase home
9
Purchase bonds
6
Place money in bank savings account
2
Purchase new car
-15
Examples of Opportunity Cost

Decide to purchase car

Opportunity cost = Stock

However, if you decided to purchase
stock rather than the car

Opportunity cost = Home
Income, Expenditures, and Taxes

Gross income is all of the money
received from all sources during the
year.
 Wages
 Tips
 Interest earned on savings and bonds
 Income from rental property
 Profits to entrepreneurs
7
Basic Income Calculations

Gross income - taxes = Disposable
income
 For most of us, disposable income is take-
home pay.

Disposable income - Fixed expenses =
Discretionary income
 Fixed expenses are contractual obligations like
rent, utilities, insurance, and car payments.
 Discretionary income is that we can spend or
save.
8
Income, SS,
Household Gross Income & Medicare
Name
($)
Taxes ($)
Jones
30,000
5,228
Roberts
50,000
9,758
Smith
70,000
16,502
Brown
90,000
23,432
Meeks
110,000
29,912
Adams
130,000
36,202
Charles
150,000
42,492
Federal
Taxes Paid
as a % of
Gross
Disposable
Fixed
Discretionary
Income
Income ($) Expenses ($)
Income ($)
17.43%
24,773
19,673
5,100
19.52%
40,243
32,683
7,560
23.57%
53,499
40,179
13,320
26.04%
66,569
41,369
25,200
27.19%
80,088
41,208
38,880
27.85%
93,798
46,998
46,800
28.33%
107,508
49,620
57,888
Department of the Treasury, Internal Revenue Service, Publication 15 (Rev. January 2008).
9
Taxes
Progressive taxes: larger percentage of
tax paid as income increases.
 Regressive taxes: larger percentage of
tax paid as income decreases.
 Proportional taxes: percentage of tax
paid remains the same at all levels of
income.

10
Example of Progressive Tax

Formula for tax percentage paid:
Tax payment in dollars
Tax Percentage 
x 100
Income in dollars
 Income tax is progressive:
$3,000
Tax percentage 
x 100  15%
$20,000
$16,000
Tax percentage 
x 100  28%
$60,000
11
Example of Regressive Tax
 Sales tax is regressive:
› Income = $20,000; savings = 0; sales tax = 5%
› Sales tax paid = $20,000 x 0.05 = 1,000
$1,000
Tax percentage 
x 100  5%
$20,000
› Income = $60,000; savings = $10,000; sales tax = 5%
› Sales tax paid = $50,000 x 0.05 = $2,500
$2,500
Tax percentage 
x 100  4.17%
$60,000
12
Example of Proportional Tax

Formula for tax percentage paid:
 Medicare tax is 1.45%
 Annual income $30,000
 Medicare tax = $30,000 x 0.0145 = $435
 Annual income $500,000
 Medicare tax=$500,000 x 0.0145 = $7,250
13
Flat Tax Proposal
Table 1-2 Flat Tax Proposal
Gross
Income ($)
30,000
40,000
50,000
60,000
70,000
80,000
90,000
100,000
110,000
120,000
130,000
140,000
Taxes Percentage of Income
Paid ($)
Paid in Taxes %
0.00
1,700
4.25
3,400
6.80
5,100
8.50
6,800
9.71
8,500
10.63
10,200
11.33
11,900
11.90
13,600
12.36
15,300
12.75
17,000
13.08
18,700
13.36
14
Factors Affecting Interest Rates
The supply of money saved is primarily the
total money that is placed in demand deposit
(checking) accounts, savings accounts, and
money market mutual funds.
 The demand for borrowed funds is all of
the money that is demanded in our economy
at a given price.

15
Factors Affecting Interest Rates
(continued)

Federal Reserve Policy
 The Federal Reserve is the central bank of the
United States.

Risk
 Systematic Risk: Risk associated with economic,
political, and sociological changes that affect all
participants on an equal basis.
 Unsystematic Risk: Risk unique to an individual,
firm, or industry.
16
Table 1-4 Supply Table: Money Saved for Seven Sample Families
Annual Savings ($000)
Annual
Interest
Rate (%) Jones
Roberts Smith
Brown
Meeks
Adams
Charles Total
0
$
- $
- $
- $
- $
- $
- $
- $
2
4
500
780
1,940
5,790
9,010
6
670
1,250
1,940
2,720
7,530
14,110
8
100
200
930
1,760
2,020
3,890
12,000
20,900
10
200
500
1,500
3,000
3,500
7,000
16,000
31,700
12
250
750
2,500
5,000
6,000
10,000
20,000
44,500
14
300
1,000
3,250
9,000
12,000
15,000
25,000
65,550
16
400
1,200
4,500
12,000
18,000
23,000
31,000
90,100
18
500
1,500
6,000
15,000
25,000
28,000
38,000 114,000
20
500
1,700
8,000
18,000
30,000
32,000
40,000 130,200
22
500
1,700
8,000
18,000
30,000
33,000
41,000 132,200
24
500
1,700
8,000
18,000
30,000
33,000
41,200 132,400
17
18
Table 1-5 Ann Smith's Demand for Money
Interest
Rate (%)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
Amount
Financed ($)
180,000
155,454
135,274
118,595
104,731
93,141
83,396
75,154
68,142
62,141
56,975
52,503
48,609
45,200
42,199
39,543
37,181
35,071
33,177
31,468
29,922
28,516
27,233
26,059
24,980
Interest
Paid ($)
0
24,546
44,726
61,405
75,269
86,859
96,604
104,846
111,858
117,859
123,025
127,497
131,391
134,800
137,801
140,457
142,819
144,929
146,823
148,532
150,078
151,484
152,767
153,941
155,020
19
20
21
Table 1-6 Money Rates, as of April 7, 2008
Type of Rate
Definition
Rate (%)
The charge on loans to depository institutions by
Discount
the New York Federal Reserve Bank
2.50
The rate banks charge each other for overnight
Federal Funds
loans in minimum amounts of $1 million
2.23
T-bill, three months The rate on government treasury bills sold at a
discount of face value in units of $10,000
1.33
The interest rate that banks charge their most
Prime
creditworthy customers
5.25
Source: Federal Reserve Statistical Release H.15 - April 7, 2008
22