Exercises: The financial system, business and innovation

Explain what the financial system is and what its basic function is: what does it do with the money of people who save, and to whom does it lend it? Give an example from your neighbourhood.

Distinguish product innovation from process innovation using two examples from a bakery: (a) inventing a gluten-free bread that did not exist before; (b) changing the kneading method to take half the time. Add your own example of each type applied to your school.

The diagram shows how money travels from savers to a business through a bank, but one of the streams is covered with a question mark.

1. a) State what travels along the covered stream (the firm returns something to the bank, and from there something reaches the households) and explain what the price of that loan is called.
2. b) Explain what the households, the bank, and the firm gain in this circuit.

The local bakery wants to buy an oven worth $\$120\,000$ that would allow it to sell twice as much bread. It does not have that money saved. Explain its options (a bank loan, waiting years to save up, looking for business partners) and what it gains and risks with each option.

A business is socially responsible when it thinks about more than just profit. Classify these actions by a juice factory as responsible or irresponsible and justify your answer: (a) buying fruit from local farmers at a fair price; (b) dumping pulp residue into the river to save money; (c) hiring local residents with training included; (d) advertising 'natural juice' when it contains $40\ \%$ added sugar.

Ten years ago in your town hardly anyone travelled by bike; today there are cycle lanes and bike-sharing schemes, and thousands of car journeys have disappeared. Explain what that innovation consisted of (was it technological, business model, or social?) and name two social transformations it has brought about.

The student cooperative at the school asks the PTA for a microloan of $\$4\,000$ to buy materials for the market, to be repaid in $4$ months at a simple interest rate of $5\ \%$ per annum.

1. a) Calculate how much interest the cooperative will pay in total and how much it will return to the PTA.
2. b) Analyse whether you think this is a good way to secure funding compared to selling advance tickets or having each member contribute money, stating one risk of each alternative.

Your family has $\$12,000$ in savings and is hesitating between three institutions to open a $1$-year fixed-term deposit:

• Listed commercial bank: offers a return of $3.0\ \%$ APR. Its loans finance large corporations and global projects seeking maximum profit for its shareholders.

• Credit cooperative (caja rural): offers $2.2\ \%$ APR. By statute, it reinvests most of its funds in SMEs and cooperatives in the local area, and customers can become members with voting rights.

• Ethical bank: offers $1.2\ \%$ APR. It publishes the destination of all its loans, which exclusively finance social impact and ecological transition initiatives.

1. a) Your cousin claims: "The only rational choice is to pick the institution that pays the most; it doesn't matter what the bank does with the money as long as it's covered by the Deposit Guarantee Scheme". Refute his stance by explaining what externalities (positive or negative) each of the three institutions' credit allocation models generate in the real economy of your local area.
2. b) Calculate the annual opportunity cost (in pesos) of choosing the credit cooperative and choosing the ethical bank instead of the commercial bank. Justify under what economic conditions and family values it would make sense to forego that return.

A highly profitable fashion company applies for a large loan. It manufactures in sweatshops with harsh conditions and pollutes heavily, but it is guaranteed to repay the money.

1. a) Argue for and against the bank lending them the money.
2. b) Explain what a bank that claims to be socially responsible would do in this case, and what pressures it would face internally (profit) and externally (customers, regulations).