Assignments Business Economics.docx

MBA Business Economics

Assignment #1
Make a list of four possible aims that a manager of a McDonald's restaurant might
have. Which of these might conflict with the interests of McDonald's shareholders?
Answers:
To give customers good service. This might prove costly in terms of staff time and thereby reduce profits. This would be against the interests of shareholders. (It might encourage more customers, however, which would be in the interests of shareholders)
To seek promotion to a more senior position. If this results in the manager working harder and ensuring that the restaurant is run more efficiently, this is likely to be in the interests of shareholders. If, however, it results in the manager leaving in the short term, this could result in reduced profits as a new manager would have to be recruited. High staff turnover can be costly.
To ensure that staff work efficiently. This could lead to staff discontent, high turnover and a drop in customer satisfaction, if targets become more important. These factors could all lead to a reduction in profits.
To have an easy life. This is likely to mean that the restaurant is run less efficiently and profits could fall.

Assignment #2

Question 1
Evaluate how the following situations will affect the demand curve for iPods.
1. Income statistics show that income of 18–25-year-olds have increased by 10 percent over the last year.
2. Efforts of music artists wanting greater protection of their music result in more stringent enforcement of copyrights and the shutdown of numerous illegal downloading sites.
3. Believing that it has significant control of the market for portable digital music players, Apple decides to raise the price of iPods with the goal of increasing profits.
4. The price of movie tickets decreases.
(Justify your answers!! Draw the diagrams on a sheet of paper first and then workout the answer.)

Anwers:

Income, is one of the factors that affect the Demand Curve.
A rightward shift in demand will occur if income increases, in the case of a normal good. However, for an inferior good, the demand curve will shift leftward noting that the consumer only purchases the good as a result of an income constraint on the purchase of a preferred good.
In the given example, we have a Normal Good (the Ipod), so if the income rises for the ages 18-25 who are the higher users of ipod, the demand for Ipod will increase which is shown by shifting the demand curve to the right.
These efforts raise the price of MP3s for music users that used to get their music for free from downloading services because they are now forced to purchase music through legal downloading sites, including iTunes. Since MP3s are a complementary good to iPods (and any other MP3 player), the demand for iPods will decrease as a result of the artists' lobbying efforts. This will cause the demand curve to shift leftward.
A rise in price will NOT shift the demand curve for iPods. Rather, the higher price will simply discourage some consumers from purchasing one and demand for iPods will decrease along the demand curve to a lower quantity at the new price.
If the price of movies decreases will not affect direct the demand curve, it will remain the same.

Question 2

Because of a legal settlement over state health care claims, in 1999 the U.S. tobacco companies had to raise the average price of a pack of cigarettes from $1.95 to $2.45. The projected decline in cigarette sales was 8 percent. What does this imply for the elasticity of cigarettes? Explain your answer fully by performing the relevant calculations (i.e., calculate the price elasticity of demand using the midpoint formula).

Answers:

Price Elasticity of Demand

Ed = abs[( %change in quantity demanded)/(%change in price)]
Ed = abs [ (ΔQ/Qm) / (ΔP/Pm) ]
Where: Qm= (Q1+Q2)/2
Pm = (P1+P2)/2 =2.2
So: %Change in Quantity Demanded=8%
% Change in Price= ΔP/Pm *100 =(2.45-1.95)/2.2 *100= 22.7%
Ed = 8/22.7 =0.35
The price elasticity of demand for cigarettes is inelastic. The percentage change in price was 22.7 percent whereas the percentage change in quantity demanded was only 8 percent. People that are addicted to cigarettes, will continue smoking, it will not stop them.


Assignment #3

John runs a print shop that makes posters for large companies. It is a very
competitive business. The market price is currently €1 per poster. He has fixed costs of €250. His variable costs are €1,000 for the first thousand posters, €800 for the second thousand, and then €750 for each additional thousand posters.
What is his AFC per poster (not per thousand!) if he prints 1000 posters? 2000? 10,000?
What is his ATC per poster if he prints 1000? 2000? 10,000?
If the market price fell to €0.70 per poster, would there be any output level at which John would not shut down production immediately?

Answers:
What is his AFC per poster (not per thousand!) if he prints 1000 posters? 2000? 10,000?

AFC (Average Fixed Cost) = TFC/no of posters

A. AFC for 1000 posters:

AFC=250/1000= €0.25
B. AFC for 2000 posters:

AFC=250/2000= €0.125
C. AFC for 10,000 posters:

AFC=250/10,000= €0.025

What is his ATC per poster if he prints 1000? 2000? 10,000?
ATC (Average Total Cost) = AVC (Average Variable Cost) + AFC (Average Fixed Cost)
Where: AVC= TVC/no of posters

A. AVC for 1000 posters: AVC=€1000/1000= €1

B. AVC for 2000 posters: For the 1st 1000 posters= €1000
For the 2nd 1000 posters= €800 So, TVC=€1800
AVC= €1800/2000 = €0.90
C. AVC for 10,000 posters:

For the 1st 1000 posters = €1000
For the 2nd 1000 posters= €800
For each additional 1000 posters= €750 therefore: 750*8 thousands posters=€6000
So, TVC=€7800
AVC= €7800/10,000 = €0.78
So, the ATC for 1000 posters:
ATC=€1+€0.25=€1.25
So, the ATC for 2000 posters:
ATC=€0.90+€0.125=€1.025
So, the ATC for 10,000 posters:
ATC=€0.78+€0.025=€0.805

If the market price fell to €0.70 per poster, would there be any output level at which John would not shut down production immediately?

If the market price fell to €0.70 per poster, John will shut down. That is because the average variable cost never falls below 78 cents per poster, so the company will always have loss.





Assignment #4
Assume that the short-run cost and demand data given in the table below confront a monopolistic competitor selling a given product and engaged in a given amount of product promotion.

Output
TC (€)
MC (€)
QD
Price (€)
MR (€)
0
25

0
60

1
40

1
55

2
45

2
50

3
55

3
45

4
70

4
40

5
90

5
35

6
115

6
30

7
145

7
25

8
180

8
20

9
220

9
15

10
265

10
10


a. Calculate the marginal cost and marginal revenue of each unit of output in the above table.
b. At what output level and at what price will the firm produce in the short run?
What will be the total profit?
c. What will happen to demand, price, and profit in the long run?

Answers:
Solution of Assignment 4:
Calculate the marginal cost and marginal revenue of each unit of output in the above table.

Marginal cost is the increase or decrease in the total cost a business will incur by producing one more unit of a product or serving one more customer.


Marginal Cost( MC)= Change in Total Cost/ Change in Quantity

Output
TC
MC
0
25

1
40
(40-25)/(1-0) =15
2
45
(45-25)/(2-1) =20
3
55
(55-45)/(3-2) =10
4
70
(70-55)/(4-3) =15
5
90
(90-70)/(5-4) =20
6
115
(115-90)/(6-5) =25
7
145
(145-115)/(7-6) =30
8
180
(180-145)/(8-7) =35
9
220
(220-180)/(9-8) =40
10
265
(265-220)/(10-9) =45

Marginal Revenue = (Change in total revenue) / (Change in number of units sold)

QD
Price
TR (Total Revenue)
MR
0
60
0*60=0

1
55
1*55=55
(55-0)/(1-0)=55
2
50
2*50=100
(100-55)/(2-1)=45
3
45
3*45=135
(135-100)/(3-2)=35
4
40
4*40=160
(160-135)/(4-3)=25
5
35
5*35=175
(175-160)/(5-4)=5
6
30
6*30=180
(180-175)/(6-5)=5
7
25
7*25=175
(175-180)/(7-6)= -5
8
20
8*20=160
(160-175)/(8-7)= -5
9
15
9*15=135
(135-160)/(9-8)= -25
10
10
10*10=100
(100-135)/(10-9)= -35


At what output level and at what price will the firm produce in the short run? What will be the total profit?

A firm maximizes its profits by choosing to supply the level of output where its marginal revenue equals its marginal cost. When marginal revenue exceeds marginal cost, the firm can earn greater profits by increasing its output. When marginal revenue is below marginal cost, the firm is losing money, and consequently, it must reduce its output. Profits are therefore maximized when the firm chooses the level of output where its marginal revenue equals its marginal cost.

the firm will produce where MR = MC. This happens in Q = 4 where MC is 15 and MR is 25. While there cannot be exactly equal, it is the point where the difference is at its minimum. Total profit is the difference between TR and TC. At Q=4, TR is €160 and TC is 70. Total profit therefore is €90 and this is the maximum profit the firm can make.

What will happen to demand, price, and profit in the long run?

The long-run is the period of time where there are no fixed variables of production. In the long run, firms are able to adjust all costs, whereas in the short run firms are only able to influence prices through adjustments made to production levels. As with any other economic equilibrium, it is defined by demand and supply.
In a perfect market, demand is perfectly elastic . The demand curve represents marginal revenue, which is important in order to calculate the quantity supplied. Therefore, regardless of how much is produced by the suppliers, the price will remain constant. In perfect competition it is impossible for a firm to earn economic profit in the long run, which is to say that a firm cannot make any more money than is necessary to cover its economic costs.
the firm, as the question states, is monopolistically competitive and NOT perfectly competitive. Therefore, in the long run, economic profits will attract new businesses in the market. The demand curve, which is downward sloping, will shift to the left and, ultimately, all firms will be making normal profits where P = LATC.

Assignment #5

Assume that an independent film company, which has up to now specialized in producing documentaries for a particular television broadcasting company, wishes to expand.
a. Identify some possible horizontal, vertical or other closely related fields.
b. What types of strategic alliance might it seek to form and with what types of company? What possible drawbacks might there be for it in such alliances?

Answers:
Solution of Assignment 5:

a. Businesses' main goal is growth· therefore they use some strategies that they can be very helpful in order to achieve their target and come up with the most accurate strategy. Since the independent film company wishes to expand, it can do this either by internal or external expansion.
Internal Expansion

The company can grow by internal expansion· that is to take the profits, save them and use them in order to invest them, ask for a loan and grow. The money can be invested to new technologies that can make the company more efficient, to advertising or marketing fields.

Internal growth is divided into 3 subcategories. Horizontal Integration occurs whether the business decides to maintain or increase the market share of the existing product. This will drive out the other players and lead the business to become the dominant player in the growth markets as a result the usage of a company's products by its current customers will be increased.
Vertical Integration deals with increasing sales through new products but belonging to different stages of the same product. Finally the Conglomerate Integration where the company develops new products in new markets.
In general of the firm decides to expand Internally it will follow one of these three strategies in which the company might design and develop new types of films (i.e movies) or build on existing products for new opportunities (i.e change the presenter or add one more presenter for their film). Furthermore, firm might decide to expand into new foreign markets through new products.
External Expansion
Another way for firms' growth is through the external expansion.
By merging a company means to combine it with one or more companies. In this agreement the two companies will agree to move ahead and coexist as a single business. On the other hand, acquisition stands when a business takes another business and establishes itself as the new owner. There are four different types of mergers and acquisition: 1. Horizontal Integration, 2. Vertical Integration (which is subdivided to backward and forward), 3. Conglomerate and 4.Concentric Integration. 2015

Horizontal Integration occurs whether business joins with another business (mergers or takes over) another business that is on the same industry and at the same stage of.therefore, in our example of the film company decide to follow the External Horizontal Integration will probably merge or acquire with another film company that is specialized in producing documentaries for a particular television broadcasting company. Thus, the film company will benefit since it reduces competition, it will increase the concentration of the company and economies of scale (since they will operate in a bigger scale so the raw materials or components will be cheaper).
Vertical Backward Integration occurs when a business joins with another business in the same industry but at an earlier stage of production (i.e a tertiary sector buying a secondary sector).
Through this, the company will increase their profits and will have the opportunity to control the Raw Materials or components since the company will be the produces .
So the film company could consider the opportunity of buying or merging with a company that produces all the equipment that they will need (cameras, microphones etc).
Vertical Forward Integration occurs when a firm buys a firm at a later stage of production (i.e a secondary sector buying a tertiary sector). Through this, the outlet for the products is guaranteed and the company will be closer to customers and it will respond faster in order to cover their needs. In our case the film company could buy or merge with a TV-station. In this way they will have a guaranteed way of broadcasting their films.
When a business buys or mergers with another business on a completely separate unrelated market a Conglomerate Integration occurs. By doing this, companies spread the risk (company 1 can survive if company 2 fails and vice versa). Also, the management ideas can be spread and the profit of 1 successful area can help to boost the other parts of the other company. So, the film company if it will decide to follow this strategy it has the opportunity to buy or merge with a supermarket chain (Rai, 2012; Pajholden, 2011) which is a domain unrelated to the film company.
Finally, the Concentric Integration occurs when two or more firms from diverse but "in line" industries merge or acquire. For example the film company to merge or acquire with a cinema chain (Rai, 2012) since the cinema chain in diverse from the film company but it is adjacent to it simultaneously.
A Strategic Alliance is consider as a formal relationship between two or more firms to follow a set of arranged upon objectives or to encounter an important business need while remaining independent organization. (Rai, 2012) It is subdivided into three subcategories: 1. Horizontal Alliances, 2. Vertical Alliances and 3. Networks. Horizontal Alliance is a contractual or informal alliance between two or more firms at a technically similar stage of production (i.e make an informal alliance for documentary films of another company). Vertical Alliance is a contractual or informal alliance between two or more firms at a technically different stage of production but on the same process (i.e make contracts with cameramen technicians' contractors). Network Alliance is an informal alliance between two or more firms across segments and includes the expansion of supply chain groups (i.e an informal alliance with electronics suppliers).

Joint Ventures is one of the most common types of strategic alliances and occurs when two or more companies pool a portion of their resources in order to create a separate but jointly owned organization. It can be performed if the firm wants to run the production facilities in another country or to create a marketing dispersal existence. Through this, company have the opportunity to gain new capacity and expertise and become more efficient (specialized staff, technology etc). The film company, if it will decide to expand through Joint Ventures, it could move their facilities in a country that has high innovation to technologies in order to create 3D-Documentaries.

b.

As mentioned before:
" Strategic Alliance is consider as a formal relationship between two or more firms to follow a set of arranged upon objectives or to encounter an important business need while remaining independent organization. (Rai, 2012) It is subdivided into three subcategories: 1. Horizontal Alliances, 2. Vertical Alliances and 3. Networks. Horizontal Alliance is a contractual or informal alliance between two or more firms at a technically similar stage of production (i.e make an informal alliance for documentary films of another company). Vertical Alliance is a contractual or informal alliance between two or more firms at a technically different stage of production but on the same process (i.e make contracts with cameramen technicians' contractors). Network Alliance is an informal alliance between two or more firms across segments and includes the expansion of supply chain groups (i.e an informal alliance with electronics suppliers).
Joint Ventures is one of the most common types of strategic alliances and occurs when two or more companies pool a portion of their resources in order to create a separate but jointly owned organization. It can be performed if the firm wants to run the production facilities in another country or to create a marketing dispersal existence. Through this, company have the opportunity to gain new capacity and expertise and become more efficient (specialized staff, technology etc). The film company, if it will decide to expand through Joint Ventures, it could move their facilities in a country that has high innovation to technologies. "
Another type of strategic alliance is franchising where companies agree to franchise operations to their party (Open Lectures, 2013). Also, many company decide to consult together for big projects and when the project is done to dissolve. Strategic alliance helps to share the risk, capital pooling and introduce to new markets.
It might decide to follow the Joint Ventures and move their facilities in a country that has high innovation to technologies. In this way they will pool a portion of their capital in order to create a separate and jointly owned organization.



They can cooperate with ACS (Advanced Camera Services), or with PRS (Professional Camera Suppliers) etc.
The drawbacks are that it needs time and lot of effort in order to build a healthy relationship and partnership with the other businesses. He fact that there will be in different countries means different culture, different language, maybe different management style. Also if the project fails then there will be a big financial loss. Beside these, there might be conflicts due to different goals and interest, due to lack of information and lack of commitment.

Assignment #6
Suppose an investment costs €12,000 and yields €5,000 per year for three years. At the end of the three years, the equipment has no value. Work out whether the investment will be profitable if the rate of discount is
(a) 5%
(b) 10%
(c) 20%
Answers:

Investment cost= €12,000
Produces €5,000 per year for three years.

(a) Discount rate= 5%
Present Value (PV)= (Future Value)/ (1+i)^n
Where:
i=discount rate
n=number of years
PV= 5000/(1.05)^1+5000/(1.05)^2+5000/(1.05)^3
PV=€13616
Net Present Value (NPV) = PV - Investment
NPV=13616-12000= €1616
Profitable Investment

(b) Discount rate= 10%

Present Value (PV)= (Future Value)/ (1+i)^n

Where:
i=discount rate
n=number of years
PV= 5000/(1.1)^1+5000/(1.1)^2+5000/(1.1)^3
PV=€12434
Net Present Value (NPV) = PV – Investment
NPV=12434-12000= €434
Profitable Investment


(c) Discount rate= 20%
Present Value (PV)= (Future Value)/ (1+i)^n
Where: i=discount rate
n=number of years
PV= 5000/(1.2)^1+5000/(1.2)^2+5000/(1.2)^3
PV=€10532
Net Present Value (NPV) = PV – Investment
NPV=10532-12000= - €1467
Non-Profitable Investment
COMPANY SHOULD PREFER THE DISCOUNT RATE OF 5% IN ORDER TO EARN MORE PROFIT.

Assignment #7 (due end of Week 9)
Assume that a group of countries forms a customs union. Is trade diversion in the union more likely or less likely in the following cases?
a. Producers in the union gain monopoly power in world trade
b. Modern developments in technology and communications reduce the differences in production costs associated with different locations.
c. The development of an internal market within the union produces substantial economies of scale in many industries.

Answers:
Solution of Assignment 7:
1.1 Trade Diversion
When a country applies the same tariff to all nations, it will always import from the most efficient producer, since the more efficient nation will provide the goods at a lower price. With the establishment of a two-sided or local free trade contract, this might not occur.
If the contract is signed with a country that is less-efficient, it will have as a result that their goods will be cheaper in the importing market than those from the more-efficient nation, since there are taxes for only one of them.
Therefore, afterward the establishing of the contract, the importing nation would obtain goods from a producer with bigger cost, instead of the low-cost producer from which it was importing. In other words, this would cause a trade diversion. (Hiwie, 2013).
a. Is trade diversion in the union more likely or less likely if producers in the union gain monopoly power in world trade.
In this case, it is important to define the reason that union countries gained monopoly power in world trade. If they gained this power in order to protect their market (local market) hence to "determinate" other producers/competitors out of business, then trade diversion is more likely to occur. So, they have large chance to become high cost producers.
On the other hand, if their monopoly power in world trade is caused from increased investments, economies of scale, and in general from minimizing the costs, then trade diversion is less likely to occur. This kind of trade will create cooperation with lower cost producers.
b. Is trade diversion in the union more likely or less likely if modern developments in technology and communications reduce the differences in production costs associated with different locations.
In this case, the trade diversion is obviously less likely. If modern developments in technology and communications reduce the differences in production costs associated with different location thus between European and non-European producers, there is less possibility of trade diversion to a higher-cost in-house manufacturer/producer.
c. Is trade diversion in the union more likely or less likely if the development of an internal market within the union produces substantial economies of scale in many industries.
In this case, the trade diversion is obviously less likely. Costs in Europe have higher possibility to fall than the costs of other countries out of Europe, and consequently there will be a smaller possibility of trade diversion into a higher cost in-house manufacturer/producer.
Assignment #8
Read carefully the case study in Box 26.3 (page 582) and answer the two questions at the end.

Answers:

Solution of Assignment 8:
(a)What long-term economic benefits might deflation generate for business and the economy in general?
Deflation is a reduction in the over-all price level of goods or services. It happens when the inflation rate falls lower than 0%. (Hans, 2006)Deflation occurs when consumers are afraid to spend money. This will result to a lower request for goods and services, as a consequence the prices will go down. When prices go down, consumers will probably not buy any good or service since they would believe that prices will go down more. Therefore, the economy will go reverse (Sam, 2009). On the other hand, with a good control deflation can offer long-term benefits to the economy. Macro-economic goals are stable prices, low unemployment and high GDP. A good control of the deflation may lead to the achievement of those targets.
To begin with, deflation can offer Higher Standard of Living. Deflation increases the standard of living for the general consumers, and inflation extinguishes people's standard of living. This is because, the reduction in prices of computers, laptops, big-screen TVs has factually made us wealthier, since it takes less working hours for the consumers in order to be able to buy these goods than earlier. If the same could happen for other goods and services, i.e the values for food and clothing fall, the same situation could occur, thus the consumers could be wealthier. The demand would increase, the unemployment rate would go down (since more employees would be hired in order to cover the consumer's needs) wages will be higher. Exactly at this point is where we need to control the deflation in order not to be driven in inflation (thus to increase the prices of the goods/services) in order for the business to make money (Nielson, 2011).
Beside this, deflation is a great opportunity in order to cover the holes of the bad economic manipulation of the last years. It is the opportunity to rebuild the market by promoting cheaper products at the price were the consumer can afford to buy. Strong demand for housing, factories, industrial equipment is very important for a healthy economy. Even when occasional defaults occur, lenders are able to sell their collateral for enough money in order to shelter the stability of their loan (Dolan, 2014).
Rising productivity and full employment ensure that real wages are rising. Even if deflation holds the growth of minimal salaries under that of actual salaries, it can still be positive. For example, actual salaries might increase by 5% per year while minimal salaries increase by 3%. With paychecks growing and workers' standard of living growing even faster, there is little cause for widespread labor unrest (Dolan, 2014).
A vital example of bad economic manipulation is US. Over the last decade, US economy produced more and larger asset-holes than every other asset-hole in every other nation. Simultaneously, their government has promised in the most dangerous and thoughtless economic policies in the history of humanity in order to prevent the healing powers of deflation. This has driven the US economy to a high risk in economy, as a result to be destroyed. After many painful years they managed to become the world's largest, wealthiest economy, and the most-productive nation (Nielson, 2011).

(b)Would an inflationary China Price effect be an example of demand-pull or cost-push inflation?
Inflation is a continued growth in the general price of goods and services over a period of time. When the price level increases, consumers purchase less goods and services. Therefore, inflation returns a decrease in the buying power per unit of money (Unknown, 2015).
Cost-push inflation happens when an economy is facing a negative cost shock. A rise in costs drives the aggregate supply curve to shift upward and left, therefore a rise in the price level, and a reduction of aggregate demand (as shown in Fig. 1). So, an inflationary effect in China is an example of cost-pull inflation.
















Demand pull inflation happens when there is a growth in aggregate monetary demand that began by a rise in one or more of the components of aggregate demand (consumption, investment, government, exports) but where aggregate supply is slow to regulate (see Figure 2).





























Assignment #9
Explain how the current account is affected by the business cycle.

Answers:

Solution of Assignment 9:

Current Account deals with:

1. Trade in goods and services
2. Income-money from investments or employment
3. Current transfers-households or countries sharing money

It is constructed with:
Goods and Services leaving from a country (i.e exporting cars to other countries, exporting fruits to other countries etc)
Income and transfers from abroad (i.e individuals receive income from investments in other countries)
Goods and services coming into a country (i.e importing TVs from another country)
Income and transfers going abroad

Current Account Balance= Credit-Debit

To sum up, current account deals with international transactions i.e the exchange of money for value. When credits are more that debits, then we have Surplus, but when debits are more than credits we have Deficit.

When a country is on a surplus, is reflected as an indication that is controlled efficiently. A surplus budget can be: used to pay off debit, save for the future, to make a purchase or developments. When expenses surpasses income, the country is on deficit, which should be sponsored by borrowing cash (Kanrat, 2015).

The business cycle in translated as variations in economic movements over a period of time. It is defined in terms of periods of: either expansion either recession. Through expansions we can observe growth in economy, therefore indicators like employment, manufacturing construction, sales and personal incomes are increased and a surplus budget occurs. On the other hand, through recessions, the economy is tightening we have a deficit budget, so the above indicators are decreased (Smith, 2015).

During the boom, the current account will tend to deteriorate. There are two reasons. The first is the direct result of higher incomes. Part of the extra incomes will be spent on imports. The second is the result of higher inflation. Higher prices of domestic goods and services relative to foreign ones will lead to both an increase in imports and a decrease in exports.
The opposite effects are likely to occur during a recession. Lower incomes and relative prices of domestic goods and services will cause a fall in imports and a rise in exports: the current account will improve.
In both cases we are assuming that other countries are not at the same time experiencing similar effects. If other countries were at the same phase of their business cycle, the above effects could be neutralized. For example, any fall in demand for imports by country A from country B could be offset by a fall in demand for imports by country B from country A. Imports and exports of both countries would fall (but not necessarily by the same amount).
Assignment #10 :
When the Central Bank announces that is putting up interest rates, how will it achieve this, given that interest rates are determined by demand and supply?

Answers:

The central bank is responsible to maintain a certain level of stability within the country's financial system.
The most influential economics tool the central bank has under its control is the ability to increase or decrease the discount rate.
Decrease to the Discount Rate
When the Fed makes a change to the discount rate, economic activity either increases or decreases depending on the intended outcome of the change. When the nation's economy is slow, the Federal Reserve may enact its power to reduce the discount rate in an effort to make borrowing more affordable for member banks.
When banks can borrow funds from the Fed at a less expensive rate, they are able to pass savings on to banking customers through lower interest rates charged on loans.
This creates an economic environment that encourages consumer borrowing and ultimately leads to an increase in consumer spending during the time in which rates are low.
Increase to the Discount Rate
When the economy is growing at a rate that may lead to hyperinflation, the Fed may increase the discount rate. When member banks cannot borrow from the central bank at an interest rate that is cost-effective, lending to the consuming public may be tightened until interest rates are reduced again.
An increase to the discount rate has a direct impact on the interest rate charged to consumers for lending products, and consumer spending shrinks when this tactic is implemented.

Increases in interest rates by the central bank are effected through open-market operations in the government bond market. When banks are in need of liquidity, they sign a repo repurchase agreement with the central bank. The central bank buys bonds from banks (providing liquidity) under the condition that the bonds will be repurchased by the banks at a specified date and price. The repurchase price will be higher than the selling price and this spread corresponds to the interest rate charged by the central bank. If the central bank wants interest rates to rise, it raises the repurchase price and, therefore, the repo rate. Banks will be forced to pay this rate if they are to avoid a liquidity shortage. Banks will pass on the higher rate to their own lending rates.