Economic Principles in Finance Industry

This article discusses the oligopoly market in Australian banking and the application of economic principles in finance industry. It covers topics such as capital adequacy requirement, capital asset pricing model, property revaluation, and different types of government policies. The article also includes a discussion on the principles of microeconomics and macroeconomics, and the use of NPV and IRR in capital budgeting.

Running head: ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
Economic Principles in Finance Industry
Name of the Student
Name of the University
Author note

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
Table of Contents
AS ligopoly inT K 1: O Australian ankingB ............................................................................................2
AST K 2....................................................................................................................................................4
SQUE TION 1.......................................................................................................................................4
SQUE TION 2.......................................................................................................................................5
SQUE TION 3.......................................................................................................................................5
SQUE TION 4.......................................................................................................................................5
SQUE TION 5.......................................................................................................................................6
SQUE TION 7.......................................................................................................................................6
SQUE TION 8.......................................................................................................................................6
SQUE TION 9.......................................................................................................................................7
Activity4.3 ...............................................................................................................................................7
R R C SEFE EN E LI T...................................................................................................................................10

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
TASK 1: Oligopoly in Australian Banking
Oligopoly in the banking industry is not an unusual phenomenon. The involving
characteristics of banking industry such as economies of scale and small retail margin of
banks. Banking industry in Australia has become increasingly concentrated with four major
banks dominating the industry. It has been determined by the Australian Government that the
four major banks have a significant pricing power. In case of an oligopoly market where only
few firms compete. The “Big four banks” of Australia which have the largest share of the
market are National Australia Bank, Westpac, Commonwealth Bank and Australia and New
Zealand Banking Group(Andrievskaya and Semenova, 2016.). These four banks dominate
the banking industry. However, Australia has a very profitable and competitive financial
sector. The four financial sectors in order to increase their profits can set any prices without
the fear of loosing the market share. These four famous banks of Australia form a cartel
arrangement in a way that the shareholders tries to maximize profits acting as a monopoly
market structure. The cartel formation therefore acts as a barrier to entry for the new entrants
in the banking industry of Australia. These banks have a higher interest margins which makes
them even more profitable. The banking sector of Australia is oligopolistic in way that they
maintain their position in the market with the help of opaque pricing. In case of an oligopoly
market the firms usually depend upon each other while deciding the price(Salim, Arjomandi
and Seufert, 2016). The banking sector in Australia is therefore oligopoly. The four major
banks of Australia comprises of eighty five percent of the banking industry. Due to the
oligopolistic market in the banking sectors of Australia, it is very difficult for any new entrant
to compete with the “big four”.
There is also a presence of market concentration within the four banks. According to a
recent research the biggest four banks of Australia will make a profit of around A$6.2 billion

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
over the next four years. As a result of the rise in market concentration in the banking
industry of Australia , there has been decrease in the market competition which lead to
increase in inefficiencies. As a result of these the banks acts as a monopoly and charges a
similar interest rates thereby decreasing market competition(Andrievskaya and Semenova,
2016). The government also supported the oligopoly market of the banking sector in
Australia where the finance minister claimed to support oligopoly in the banking industry.
High level of concentration in the market also reported to have higher prices along with
decrease in the competitiveness in the market. As a result of this the customers used to have
blind faith in these banks and therefore, it also resulted to huge profitability. In the year 2010,
the banks of Australia had also increased its lending rates in case of housing loans.
Oligopolistic markets tends to set up high barriers for entry and also depends on how the
other firms in the market depends. The Australian banking sector therefore has the similar
characteristics. According to the Australian Banking and financial report, the financial
institutions of Australia has both cost and scale advantages along with investment advantage.
The banking industry of Australia had a highly concentrated Herfindahl Hirschman
Index. As a result of the acquisition taken place by Westpac and the Commonwealth Bank of
Australia, there had been increase in the market concentration over the years. As a result of
market concentration there has been rise in the profitability(Turner and Nugent 2015). The
market leaders are therefore able to manipulate the market. The shareholders of the ‘big four”
are similar though the “ big four” are the different entities altogether. However, there had
been a lot of reform in the banking sector of Australia. As a result of rise in the con centration
in the market, there had been a lot of reports of the economic inefficiencies. There had been
also a result of increase in the consumer surplus due to the monopolistic behavior of the
banks. The four pillar policies were made by the Australian government in order to avoid the
mergers of the four major Australian banks. The policies had also been criticized for not been

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
competitive. The banks of Australia had therefore adopted the four pillar policies to avoid
acquisitions. Along with adopting the policies the banks also had monopolistic nature which
lead to the rise in deadweight loss which the society actually suffers. The banking industry
structure of Australia therefore acts similar to an oligopoly market. With the help of
concentration ratio and the Herfindahl Hirschman Index the competition within an industry
can be measured(Salim, Arjomandi and Seufert 2016). The banking sector market of
Australia is dominated by the only four banks out of fifty four banks. In the fiscal year of
2017 it had earned a profit of A$31.5 billion. As a result of highly concentrated market, the
performance of the banks are also affected. However the dominating firms enjoy higher
profitability as they can implement prices and charges according to their will.
The big four banks of Australia therefore seemed to have an oligopolistic market. It
also has a high market concentration along with high HHI index. High concentration in
market has led to low market efficiencies(Andrievskaya and Semenova2016). Therefore, in
order to increase the market efficiencies there is a need of regulation for the banks. However,
the regulation of the large banks will not be possible by the domestic banks as they will not
be able to compete with the large banks. However, the entry of global banks in the Australian
banking sector is recommended which can very well lower the concentration in market.
Therefore, in order to conclude it can be stated that the banking sector of Australia has both
oligopoly and monopolistic competition.
TASK 2
QUESTION 1
a) Classical economics – it originated in the late eighteenth century which refers to the
dominant school of thought for economics whose originator was the economist Adam
Smith.

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
b) Keynesian economics – Keynesian economics was founded by John Maynard Keynes
after Great Depression is an economic theory of total spending and its effects on output.
c) Supply side economics- this is a theory of macroeconomics which states that
economic growth can be achieved with the help of tax cuts.
QUESTION 2
a) Mortgages and interest rates- the longer the time taken to pay the mortgage, the
buying cost of the houses become higher because interest is need to be paid for the
longer period of time( Hasan 2013).
b) Insurance premiums for motor vehicles- it is also known as automotive insurance
where the insurer assumes that any loss may incur through the result of accident.
QUESTION 3
Capital adequacy requirement is considered as the amount of capital that the banks or
other financial institutions have to hold as per the requirement by the financial regulators.
This capital adequacy requirement is expressed in the form of capital adequacy ratio of equity
and the banks or other financial institutions are required to hold this ratio as a percentage of
the risk-weighted assets (Fatima 2014).
QUESTION 4
The Capital Asset Pricing Model is considered as a financial model that helps in
describing the relationship between systematic risk and expected returns for the assets or
particular stock. The wide application of capital asset pricing model can be seen throughout
the finance process in order o price the risky securities, to generate expected returns for the
assets and to calculate the costs of capital (Ross 2013).

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
QUESTION 5
Some of the major reasons for property revaluation are to gain understanding about
the difference between value and price; to gain effective guideline for the investment
decisions; to get the correct market value of the property at the time of selling or buying; to
obtain the legal documents about the property; to know the extent of tax deduction and others
(Beaglehole 2015).
QUESTION 6
The main use of Compound Interest can be seen for the calculation of interest on the
initial principles along with the accumulated interest of previous period. The main use of Net
Present Value can be seen in analyzing the profitability of a particular project. Internal Rate
of Return is used for the estimation of the profitability aspect of a potential investment (Rossi
2015).
QUESTION 7
Banks provides their customers with different kinds of products, Six of them are
Savings Account that is used to save money; Current Account that is used by businesses;
Debit Cards that are used for money withdrawal; Credit Cards that is used for various
shopping and other payments; Loans and Mortgages (Chochoľákováet al. 2015).
QUESTION 8
Banks are governed by government regulations along with certain requirements like
Basel I, Basel II and Basel III. The banks are needed to consider the monetary policy of the
countries along with the basic banking standards. However, the insurance companies are
regulated by statutory law, administrative regulations and jurisprudence as these regulate the
insurance industry (Baltenspergeret al. 2014).

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
QUESTION 9
In case of studying property markets various statistical data are used. Using the
various statistical techniques property markets can be learnt. Property markets are also known
as the real estate. One statistical technique used in the property market is regression, for
example stepwise regression model and correlation can also be used.
4.3 Activity
QUESTION 1
a) Banking industry- the knowledge of the principles of economics are applied to
the different financial industries. There are many functions of money in the
economy
b) Insurance industry- this industry acts as a mediator between policy maker and
capital market. Application of capital asset pricing model is used.
QUESTION 2
Decision making is one of the key factors of managerial economics. The different
economic aspects also help the managers in taking different economic decisions. It is also a
process in which the business makes decision.
QUESTION 3
a) In the finance industry, one major way to evaluate the wok performance is the analysis of
the performance metrics. Some of the crucial performance metrics are revenue per employee,
attendance, turnover, efficiency and others.

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
(b) The required feedback of the performance can be gained through different appraisal
programs, employee survey and personal view point of other employees.
QUESTION 4
Different types of taxation, interest rates, money supply and the budget of the
government are the different forms of government policies (Guttmann and Rodgers 2015).
Monetary policies and the fiscal policies are the two types of economic policy. This kind of
policy usually influences the behaviour of the economy. Economic principles on the other
hand helps in solving the problems related to business.
QUESTION 5
Positive economics is that branch of economics which is concerned with the
representation of the economic phenomena. Unlike normative economics it is concerned with
the development of statements that are positive.it also includes th4e testing of the theories of
economics. Positive economics also answers “what is” when a certain coursed of action is to
be taken.
QUESTON 6
a) Principles of microeconomics – this usually refers to the fundamentals of
microeconomics. This branch of economics shows how an individual maximizes its
utility.
b) Principles of macroeconomics- the study of the economic issues which affects the
entire nation or economy such as inflation, unemployment rate and interest rates is
defined as macroeconomics.

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
QUESTION 7
NPV is considered as the difference between the present value of cash inflow and the
present value of cash outflow for a certain period. NPV can be described as the sum of all
discounted future cash flows (Hasan 2013).
The calculation of NPV is done by the calculation of the costs as well as benefits for
each period of time of the investment.
Year Net Cash Flow after Tax Cost of Capital
Discounting
Factor Value
@9% Discounted Cash Flows
0 3,00,000-$ 9% 1 3,00,000-$
1 40,000$ 9% 0.92 36,697$
2 60,000$ 9% 0.84 50,501$
3 80,000$ 9% 0.77 61,775$
4 1,00,000$ 9% 0.71 70,843$
5 1,20,000$ 9% 0.65 77,992$
Net Present Value (NPV)
Internal Rate of Return (IRR)
2,192.99-$
8.76%
QUESTION 8
IRR can be considered as a metric and its use can be seen in capital budgeting for
estimating the profitability of potential investments. IRR is a rate of discount and it makes the
net present value of a particular project’s all cash flow equal to zero (Andor, Mohanty and
Toth 2015).
QUESTION 9
According to the principle of Cost and Benefits analysis, the cost of particular
financial information in the financial statement must not offset the benefit of that information
to the users of financial information. In other words, this aspect implies that the financial
information is not free. Thus, the principle of cost and benefit is considered as a common
sense of rule (Nas 2016).

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
QUESTION 10
The circular flow of income states the ways by which money flows to the economy. It
is defined by the flow of money, goods and services which runs in the opposite direction in a
closed circuit. The flow of money is between the consumers and the producers or between the
firms and the households.
QUESTION 11
Modern Capitalism is considered as an economic system that is based on the private
ownership of the production, distribution and exchange means. On the other hand, it can be
said that modern capitalism can be regarded as privately owned production mean economic
system where the products are produced for the purpose of maximizing the profit (Sombart
2017).
QUESTION 12
a) Intrinsic theory of value – it is also known as fundamental value which relates to the
value of goods, company, stock or services.
b) Labour theory of value – according to this theory the economic value of a commodity
depends upon the amount of labour required to produce it.

ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
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ECONOMIC PRINCIPLES OF FINANCE INDUSTRY
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