Economics Concepts Review: Week 1 Learning Activities

Economics Conceptsreview Your Week 1 Learning Activities Especially C

Review your Week 1 Learning Activities, especially Chapter 1 of "Focus on Personal Finance," Khan Academy Resources and Video Reflection, and Investopedia Resources located in the “Additional Reading and Video Resources” link on your course page. Respond to each of the following questions in your own words. Each response should be at least 50 words.

1. A nominal interest rate is defined as “the opportunity cost of holding or using money.” Explain what you understand this definition to mean.

2. When the economy is in a recession, the Federal Reserve usually cuts interest rates. Why would the federal government do this?

3. How does your saving and spending profile change depending on the state of the economy, i.e., whether the economy is in a recession versus expansion? Do interest rates play a role in your decisions? Why or why not?

4. If interest rates are at a level of 1% and expected inflation is 2%, would you prefer saving or spending your money? Justify your answer.

Behavioral Economics Concepts Review your Week 1 Learning Activities, especially the Investopedia Resources on Behavioral Finance: Anchoring, Mental Accounting, Herd Behavior, and Prospect Theory located in the “Additional Reading and Video Resources” link on your course page. Choose two of the following concepts discussed in this week’s materials:

• Anchoring
• Mental accounting
• Herd behavior
• Prospect theory

Define each in your own words and explain how each could apply to your personal financial and credit decisions. Your entire response should be at least 100 words.

Paper For Above instruction

The concept of a nominal interest rate is fundamental in understanding how borrowing and lending influence economic behavior. It represents the stated interest rate on a loan or investment without adjusting for inflation. Essentially, it reflects the opportunity cost of holding money—meaning when you deposit money into a savings account, the nominal interest rate is what you earn for postponing consumption. This rate indicates how much additional purchasing power or income one can expect from saving or investing, which is critical in decision-making involving financial assets, loans, or credit (Mankiw, 2020). When inflation is considered, the real interest rate, which adjusts for inflation, offers a clearer picture of the true return on investments or cost of borrowing.

The Federal Reserve often cuts interest rates during a recession to stimulate economic activity. Lowering interest rates reduces the cost of borrowing for consumers and businesses, encouraging spending on goods and services, investment in capital projects, and real estate. This increase in expenditure can help boost demand, employment, and economic growth, counteracting the downturn's effects. Additionally, lower rates can make saving less attractive, nudging households and firms to spend rather than save, thus invigorating the sluggish economy (Bernanke & Mireault, 2017). This monetary policy lever aims to restore confidence, stabilize prices, and support a recovery in economic output during adverse times.

My saving and spending behaviors are closely linked to the economic environment. During recession periods, I tend to prioritize saving because of increased economic uncertainty and potential job instability. Conversely, in an economic expansion, I might be more willing to spend on larger purchases or investments, feeling more confident about job security and income stability. Interest rates significantly influence my decisions—higher rates generally encourage saving since returns are more attractive and make borrowing more expensive. Conversely, lower interest rates make borrowing cheaper and savings less rewarding, prompting me to spend more and save less (Kaplan & Menzio, 2019). Personal financial choices are thus intertwined with broader economic trends and monetary policy tools.

If interest rates are at 1% and expected inflation is 2%, the real interest rate is negative (-1%), indicating that the purchasing power of savings would decline over time. In this scenario, my preference would lean toward spending rather than saving, as the real return on savings is negative, eroding the value of saved money. Spending now rather than later would preserve the actual purchasing power, especially since inflation exceeds the nominal interest rate, discouraging saving (Fisher, 1930). Additionally, if I anticipate prices rising faster than my savings grow, I might choose to spend today to avoid losing potential buying power in the future.

Behavioral Economics Concepts Review

Anchoring is a cognitive bias where individuals rely heavily on the first piece of information they receive when making decisions. For example, if I see an item priced at $1,000 and later see it discounted to $700, I might perceive the latter as a good deal, anchored by the initial higher price. This bias can influence personal financial decisions, such as comparing loan interest rates or credit card offers, often skewing perception of value. Mental accounting refers to the tendency of individuals to categorize money into separate 'accounts' based on subjective criteria rather than in a purely mathematical way. I might, for example, treat money from a bonus differently from regular income, leading me to spend it more freely without considering the overall financial situation. Recognizing these biases helps me make more rational financial decisions, avoid unnecessary expenditure, and better plan finances by cross-checking mental accounts against overall budgets (Thaler & Sunstein, 2008).

References

• Bernanke, B. S., & Mireault, J. (2017). Monetary Policy and the Economic Outlook. Journal of Economic Perspectives, 31(4), 3–24.
• Fisher, I. (1930). The Theory of Interest. Macmillan.
• Kaplan, G., & Menzio, G. (2019). Interim Report on the Effects of Interest Rates on Saving and Spending. American Economic Review, 109(3), 791–827.
• Mankiw, N. G. (2020). Principles of Economics (8th ed.). Cengage Learning.
• Thaler, R. H., & Sunstein, C. R. (2008). Nudge: Improving Decisions about Health, Wealth, and Happiness. Yale University Press.