Demonetization is the act of stripping a currency unit of its status as legal tender. It occurs whenever there is a change in national currency. The current form or forms of money is pulled from circulation and retired, often to be replaced with new notes or coins. Sometimes, a country completely replaces the old currency with a new currency.

KEY TAKEAWAYS

• Demonetization is a drastic intervention into the economy that involves removing the legal tender status of a currency.

• Demonetization can cause chaos or a serious downturn in an economy if it goes wrong.

• Demonetization has been used as a tool to stabilize the currency and fight inflation, facilitate trade and access to markets, and push informal economic activity into more transparency and away from black and gray markets.

• A famous example of demonetization occurred in 2016 when India demonetized 86% of its nation's currency.1

• Demonetized may also refer to social media or digital content that formerly qualified for revenue distribution but has since been denied income proceeds.

Understanding Demonetization

Removing the legal tender status of a unit of currency is a drastic intervention into an economy because it directly affects the medium of exchange used in all economic transactions. It can help stabilize existing problems, or it can cause chaos in an economy, especially if undertaken suddenly or without warning. That said, demonetization is undertaken by nations for a number of reasons.

Demonetization has been used to stabilize the value of a currency or combat inflation. The Coinage Act of 1873 demonetized silver as the legal tender of the United States, in favor of fully adopting the gold standard, in order to stave off disruptive inflation as large new silver deposits were discovered in the American West. Several coins, including a two-cent piece, three-cent piece, and half-dime were discontinued.

The withdrawal of silver from the economy resulted in a contraction of the money supply, which contributed to a recession throughout the country.2 In response to the recession and political pressure from farmers and from silver miners and refiners, the Bland-Allison Act remonetized silver as legal tender in 1878.3

In a more modern example, the Zimbabwean government demonetized its dollar in 2015 as a way to combat the country’s hyperinflation. At its peak, Zimbabwe's hyperinflation reached month-over-month growth of 79.6 million percent growth and year-over-year growth of 89.7 sextillion percent.4 The three-month process involved expunging the Zimbabwean dollar from the country’s financial system and solidifying the U.S. dollar, the Botswana pula, and the South African rand as the country’s legal tender in a bid to stabilize the economy.5

Some countries have demonetized currencies in order to facilitate trade or form currency unions. An example of demonetization for trade purposes occurred when the nations of the European Union officially began to use the euro as their everyday currencies in 2002. When the physical euro bills and coins were introduced, the old national currencies, such as the German mark, the French franc, and the Italian lira were demonetized. However, these varied currencies remained convertible into Euros at fixed exchange rates for a while to assure a smooth transition.6

The opposite of demonetization is remonetization, in which a form of payment is restored as legal tender.

Pros and Cons of Demonetization

There are several advantages when a nation demonetizes its currency. Fraudulent financial practices may be minimized as individuals will be unable to exchange illegal tender with banks. This also includes the potential reduction in tax evasion, pumping additional revenue into a nation's economy.

Demonetizing physical paper tender also demonstrates an advancing banking system, as digital currency can be more accessible, safer to store, and easier to transfer ownership. Organized industries and companies often benefit the greatest due to an easier transition.

Demonetization isn't without its faults. It's inconvenient for the nation's citizens and may be confusing when only select denominations are phased out over time. As a result of the disturbance, a nation's economy may temporarily experience a period of stalled growth in the short-term as the demonetization process occurs.

There are costly logistical measures to be taken as well. ATMs and other means of disbursing cash must be modified and recoded. Consumer prices must be reframed to ensure proper change can be given if needed. Daily wage earners—often among the poorest with no to minimal savings—may continue to be paid in defunct tender and must miss work to exchange their earnings with a bank.

Demonetization

Pros

• Often results in decreased tax evasion and increased tax revenue

• Ofte nresults in higher long-term GDP due to higher tax revenue being reinvested in the nation

• Fosters innovation by converting currency to digital currency and promoting digital transactions

• Reduces overall crime by enhancing transparency and discouraging the circulation of black money.

Cons

• Imposes a burden on citizens, especially those who must convert one currency to another

• Likely stalls a nation's GDP during the conversion process

• Incurs expensive administrative costs including printing, adjusting ATMs, and marketing the changes.

• Negatively impacts and even stops cash-driven sectors

• Introduces new types of currency risk such as cybercrime

Demonetization Example in India

Lastly, demonetization has been tried as a tool to modernize a cash-dependent developing economy and to combat corruption and crime (counterfeiting, tax evasion). In 2016, the Indian government decided to demonetize the 500- and 1000- rupee notes, the two biggest denominations in its currency system; these notes accounted for 86% of the country’s circulating cash.

With little warning, India's Prime Minister Narendra Modi announced to the citizenry on Nov. 8, 2016, that those notes were worthless, effective immediately—and they had until the end of the year to deposit or exchange them for newly introduced 2000 rupee and 500 rupee bills.78

Indian Rupee: Value in Dollars

Chaos ensued in the cash-dependent economy (some 78% of all Indian customer transactions are in cash), as long, snaking lines formed outside ATMs and banks, which had to shut down for a day. The new rupee notes have different specifications, including size and thickness, requiring re-calibration of ATMs: only 60% of the country’s 200,000 ATMs were operational. Even those dispensing bills of lower denominations faced shortages. The government’s restriction on daily withdrawal amounts added to the misery, though a waiver on transaction fees did help a bit. Severe cash shortages were recurring even through 2018.9

Small businesses and households struggled to find cash and reports of daily wage workers not receiving their dues surfaced. The rupee fell sharply against the dollar. 

Game theory is a theoretical framework for conceiving social situations among competing players. In some respects, game theory is the science of strategy, or at least the optimal decision-making of independent and competing actors in a strategic setting.

KEY TAKEAWAYS

• Game theory is a theoretical framework to conceive social situations among competing players and produce optimal decision-making of independent and competing actors in a strategic setting. 

• Using game theory, real-world scenarios for such situations as pricing competition and product releases (and many more) can be laid out and their outcomes predicted. 

• Scenarios include the prisoner's dilemma and the dictator game among many others.

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Game Theory

How Game Theory Works

The key pioneers of game theory were mathematician John von Neumann and economist Oskar Morgenstern in the 1940s.1 Mathematician John Nash is regarded by many as providing the first significant extension of the von Neumann and Morgenstern work.

The focus of game theory is the game, which serves as a model of an interactive situation among rational players. The key to game theory is that one player's payoff is contingent on the strategy implemented by the other player. 

The game identifies the players' identities, preferences, and available strategies and how these strategies affect the outcome. Depending on the model, various other requirements or assumptions may be necessary.

Game theory has a wide range of applications, including psychology, evolutionary biology, war, politics, economics, and business. Despite its many advances, game theory is still a young and developing science.

According to game theory, the actions and choices of all the participants affect the outcome of each. And it's assumed players within the game are rational and will strive to maximize their payoffs in the game.2

Game Theory Definitions

Any time we have a situation with two or more players that involve known payouts or quantifiable consequences, we can use game theory to help determine the most likely outcomes. Let's start by defining a few terms commonly used in the study of game theory:

• Game: Any set of circumstances that has a result dependent on the actions of two or more decision-makers (players)

• Players: A strategic decision-maker within the context of the game

• Strategy: A complete plan of action a player will take given the set of circumstances that might arise within the game

• Payoff: The payout a player receives from arriving at a particular outcome (The payout can be in any quantifiable form, from dollars to utility.)

• Information set: The information available at a given point in the game (The term information set is most usually applied when the game has a sequential component.)

• Equilibrium: The point in a game where both players have made their decisions and an outcome is reached

The Nash Equilibrium

Nash equilibrium is an outcome reached that, once achieved, means no player can increase payoff by changing decisions unilaterally. It can also be thought of as "no regrets," in the sense that once a decision is made, the player will have no regrets concerning decisions considering the consequences.

The Nash equilibrium is reached over time, in most cases. However, once the Nash equilibrium is reached, it will not be deviated from. After we learn how to find the Nash equilibrium, take a look at how a unilateral move would affect the situation. Does it make any sense? It shouldn't, and that's why the Nash equilibrium is described as "no regrets." Generally, there can be more than one equilibrium in a game.

However, this usually occurs in games with more complex elements than two choices by two players. In simultaneous games that are repeated over time, one of these multiple equilibria is reached after some trial and error. This scenario of different choices overtime before reaching equilibrium is the most often played out in the business world when two firms are determining prices for highly interchangeable products, such as airfare or soft drinks.

Impact on Economics and Business

Game theory brought about a revolution in economics by addressing crucial problems in prior mathematical economic models. For instance, neoclassical economics struggled to understand entrepreneurial anticipation and could not handle the imperfect competition. Game theory turned attention away from steady-state equilibrium toward the market process.

In business, game theory is beneficial for modeling competing behaviors between economic agents. Businesses often have several strategic choices that affect their ability to realize economic gain. For example, businesses may face dilemmas such as whether to retire existing products or develop new ones, lower prices relative to the competition, or employ new marketing strategies. Economists often use game theory to understand oligopoly firm behavior. It helps to predict likely outcomes when firms engage in certain behaviors, such as price-fixing and collusion.

Types of Game Theories

Although there are many types (e.g., symmetric/asymmetric, simultaneous/sequential, etc.) of game theories, cooperative and non-cooperative game theories are the most common. Cooperative game theory deals with how coalitions, or cooperative groups, interact when only the payoffs are known. It is a game between coalitions of players rather than between individuals, and it questions how groups form and how they allocate the payoff among players.

Non-cooperative game theory deals with how rational economic agents deal with each other to achieve their own goals. The most common non-cooperative game is the strategic game, in which only the available strategies and the outcomes that result from a combination of choices are listed. A simplistic example of a real-world non-cooperative game is rock-paper-scissors. 

Examples of Game Theory

There are several "games" that game theory analyzes. Below, we will just briefly describe a few of these.

The Prisoner's Dilemma

The Prisoner's Dilemma is the most well-known example of game theory. Consider the example of two criminals arrested for a crime. Prosecutors have no hard evidence to convict them. However, to gain a confession, officials remove the prisoners from their solitary cells and question each one in separate chambers. Neither prisoner has the means to communicate with each other. Officials present four deals, often displayed as a 2 x 2 box.

1. If both confess, they will each receive a five-year prison sentence. 

2. If Prisoner 1 confesses, but Prisoner 2 does not, Prisoner 1 will get three years and Prisoner 2 will get nine years. 

3. If Prisoner 2 confesses, but Prisoner 1 does not, Prisoner 1 will get 10 years, and Prisoner 2 will get two years. 

4. If neither confesses, each will serve two years in prison.

The most favorable strategy is to not confess. However, neither is aware of the other's strategy and without certainty that one will not confess, both will likely confess and receive a five-year prison sentence. The Nash equilibrium suggests that in a prisoner's dilemma, both players will make the move that is best for them individually but worse for them collectively.

The expression "tit for tat" has been determined to be the optimal strategy for optimizing a prisoner's dilemma. Tit for tat was introduced by Anatol Rapoport, who developed a strategy in which each participant in an iterated prisoner's dilemma follows a course of action consistent with their opponent's previous turn. For example, if provoked, a player subsequently responds with retaliation; if unprovoked, the player cooperates.

Dictator Game

This is a simple game in which Player A must decide how to split a cash prize with Player B, who has no input into Player A’s decision. While this is not a game theory strategy per se, it does provide some interesting insights into people’s behavior. Experiments reveal about 50% keep all the money to themselves, 5% split it equally, and the other 45% give the other participant a smaller share.

The dictator game is closely related to the ultimatum game, in which Player A is given a set amount of money, part of which has to be given to Player B, who can accept or reject the amount given. The catch is if the second player rejects the amount offered, both A and B get nothing. The dictator and ultimatum games hold important lessons for issues such as charitable giving and philanthropy.

Volunteer’s Dilemma

In a volunteer’s dilemma, someone has to undertake a chore or job for the common good. The worst possible outcome is realized if nobody volunteers. For example, consider a company in which accounting fraud is rampant, though top management is unaware of it. Some junior employees in the accounting department are aware of the fraud but hesitate to tell top management because it would result in the employees involved in the fraud being fired and most likely prosecuted.

Being labeled as a whistleblower may also have some repercussions down the line. But if nobody volunteers, the large-scale fraud may result in the company’s eventual bankruptcy and the loss of everyone’s jobs.

The Centipede Game

The centipede game is an extensive-form game in game theory in which two players alternately get a chance to take the larger share of a slowly increasing money stash. It is arranged so that if a player passes the stash to their opponent who then takes the stash, the player receives a smaller amount than if they had taken the pot.

The centipede game concludes as soon as a player takes the stash, with that player getting the larger portion and the other player getting the smaller portion. The game has a pre-defined total number of rounds, which are known to each player in advance.

Limitations of Game Theory

The biggest issue with game theory is that, like most other economic models, it relies on the assumption that people are rational actors that are self-interested and utility-maximizing. Of course, we are social beings who do cooperate and do care about the welfare of others, often at our own expense. Game theory cannot account for the fact that in some situations we may fall into a Nash equilibrium, and other times not, depending on the social context and who the players are.

What Are the Games Being Played in Game Theory?

It is called game theory since the theory tries to understand the strategic actions of two or more "players" in a given situation containing set rules and outcomes. While used in several disciplines, game theory is most notably used as a tool within the study of business and economics. The "games" may involve how two competitor firms will react to price cuts by the other, whether a firm should acquire another, or how traders in a stock market may react to price changes. In theoretic terms, these games may be categorized as prisoner's dilemmas, the dictator game, the hawk-and-dove, and Bach or Stravinsky.

What Are Some of the Assumptions About These Games?

Like many economic models, game theory also contains a set of strict assumptions that must hold for the theory to make good predictions in practice. First, all players are utility-maximizing rational actors that have full information about the game, the rules, and the consequences. Players are not allowed to communicate or interact with one another. Possible outcomes are not only known in advance but also cannot be changed. The number of players in a game can theoretically be infinite, but most games will be put into the context of only two players.

What Is a Nash Equilibrium?

The Nash equilibrium is an important concept referring to a stable state in a game where no player can gain an advantage by unilaterally changing a strategy, assuming the other participants also do not change their strategies. The Nash equilibrium provides the solution concept in a non-cooperative (adversarial) game. It is named after John Nash who received the Nobel Prize in 1994 for his work.3

Who Came Up with Game Theory?

Game theory is largely attributed to the work of mathematician John von Neumann and economist Oskar Morgenstern in the 1940s and was developed extensively by many other researchers and scholars in the 1950s.1

It remains an area of active research and applied science to this day.

A joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity.

In a JV, each of the participants is responsible for profits, losses, and costs associated with it. However, the venture is its own entity, separate from the participants' other business interests.

KEY TAKEAWAYS

• A joint venture (JV) is a business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task.

• They are a partnership in the colloquial sense of the word but can take on any legal structure.

• A common use of JVs is to partner up with a local business to enter a foreign market.

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Joint Venture

Understanding Joint Ventures (JVs)

Joint ventures, although they are a partnership in the colloquial sense of the word, can be formed between any legal structure. Corporations, partnerships, limited liability companies (LLCs), and other business entities can all be used to form a JV. Despite the fact that the purpose of JVs is typically for production or for research, they can also be formed for a continuing purpose. Joint ventures can combine large and smaller companies to take on one or several big, or little, projects and deals.

There are four main reasons why companies form joint ventures:

Leverage Resources

A joint venture can take advantage of the combined resources of both companies to achieve the goal of the venture. One company might have a well-established manufacturing process, while the other company might have superior distribution channels.

Cost Savings

By using economies of scale, both companies in the JV can leverage their production at a lower per-unit cost than they would separately. This is particularly appropriate with technology advances that are costly to implement. Other cost savings as a result of a JV can include sharing advertising or labor costs.

Combined Expertise

Two companies or parties forming a joint venture might each have unique backgrounds, skillsets, and expertise. When combined through a JV, each company can benefit from the other's expertise and talent within their company.

Regardless of the legal structure used for the JV, the most important document will be the JV agreement that sets out all of the partners' rights and obligations. The objectives of the JV, the initial contributions of the partners, the day-to-day operations, and the right to the profits, and the responsibility for losses of the JV are all set out in this document. It is important to draft it with care, to avoid litigation down the road.

Enter Foreign Markets

Another common use of JVs is to partner up with a local business to enter a foreign market. A company that wants to expand its distribution network to new countries can usefully enter into a JV agreement to supply products to a local business, thus benefiting from an already existing distribution network. Some countries also have restrictions on foreigners entering their market, making a JV with a local entity almost the only way to do business in the country.

Image by Sabrina Jiang © Investopedia 2020

Paying Taxes on a Joint Venture

When forming a JV, the most common thing the two parties can do is to set up a new entity. But because the JV itself isn't recognized by the Internal Revenue Service (IRS), the business form between the two parties helps determine how taxes are paid. If the JV is a separate entity, it will pay taxes as any other business or corporation does. So if it operates as an LLC, then the profits and losses would pass through to the owners' personal tax returns just like any other LLC.1

The JV agreement will spell out how profits or losses are taxed. But if the agreement is merely a contractual relationship between the two parties, then their agreement will determine how the tax is divided up between them.

Joint Ventures vs. Partnerships and Consortiums

A joint venture (JV) is not a partnership. That term is reserved for a single business entity that is formed by two or more people. Joint ventures join two or more different entities into a new one, which may or may not be a partnership.

The term "consortium" may be used to describe a joint venture. However, a consortium is a more informal agreement between a bunch of different businesses, rather than creating a new one. A consortium of travel agencies can negotiate and give members special rates on hotels and airfares, but it does not create a whole new entity.

Examples of Joint Ventures

Once the joint venture (JV) has reached its goal, it can be liquidated like any other business or sold. For example, in 2016, Microsoft Corporation (NASDAQ: MSFT) sold its 50% stake in Caradigm, a JV it had created in 2011 with General Electric Company (NYSE: GE).234 The JV was established to integrate Microsoft’s Amalga enterprise healthcare data and intelligence system, along with a variety of technologies from GE Healthcare. Microsoft has now sold its stake to GE, effectively ending the JV. GE is now the sole owner of the company and is free to carry on the business as it pleases.

Sony Ericsson is another famous example of a JV between two large companies. In this case, they partnered in the early 2000s with the aim of being a world leader in mobile phones.5 After several years of operating as a JV, the venture eventually became solely owned by Sony.

Why Do Firms Enter into Joint Ventures?

There are many reasons to join forces with another company on a temporary basis, including for purposes of expansion, development of new products, or entering new markets (particularly overseas).  JVs are a common method to combine the business prowess, industry expertise, and personnel of two otherwise unrelated companies. This type of partnership allows each participating company an opportunity to scale its resources to complete a specific project or goal while reducing total cost and spreading out the risk and liabilities inherent to the task. 

What Are the Primary Advantages of Forming a Joint Venture?

A joint venture affords each party access to the resources of the other participant(s) without having to spend excessive amounts of capital. Each company is able to maintain its own identity and can easily return to normal business operations once the joint venture is complete. Joint ventures also provide the benefit of shared risk.

What Are Some Disadvantages of Forming a Joint Venture?

Joint venture contracts commonly limit the outside activities of participant companies while the project is in progress. Each company involved in a joint venture may be required to sign exclusivity agreements or a non-compete agreement that affects current relationships with vendors or other business contacts. The contract under which joint ventures are created may also expose each company to liability inherent to a partnership unless a separate business entity is established for the joint venture. Furthermore, while companies participating in a joint venture share control, work activities, and use of resources are not always divided equally.

Do Joint Ventures Need an Exit Strategy?

A joint venture is intended to meet a particular project with specific goals, so the venture ends when the project is complete. An exit strategy is important as it provides a clear path on how to dissolve the joint business, avoiding any drawn-out discussions, costly legal battles, unfair practices, negative impacts on customers, and any possible financial loss. In most joint ventures, an exit strategy can come in three different forms: sale of the new business, a spinoff of operations, or employee ownership. Each exit strategy offers different advantages to partners in the joint venture, as well as the potential for conflict.

Money laundering is the illegal process of making large amounts of money generated by a criminal activity, such as drug trafficking or terrorist funding, appear to have come from a legitimate source. The money from the criminal activity is considered dirty, and the process “launders” it to make it look clean.

Money laundering is a serious financial crime that is employed by white-collar and street-level criminals alike.1 Most financial companies have anti-money-laundering (AML) policies in place to detect and prevent this activity.2

KEY TAKEAWAYS

• Money laundering is the illegal process of making “dirty” money appear legitimate instead of ill-gotten.

• Criminals use a wide variety of money-laundering techniques to make illegally obtained funds appear clean.

• Online banking and cryptocurrencies have made it easier for criminals to transfer and withdraw money without detection.

• The prevention of money laundering has become an international effort and now includes terrorist funding among its targets.

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Click Play to Learn How Money Laundering Works

How Money Laundering Works

Money laundering is essential for criminal organizations that wish to use illegally obtained money effectively. Dealing in large amounts of illegal cash is inefficient and dangerous. Criminals need a way to deposit the money in legitimate financial institutions, yet they can only do so if it appears to come from legitimate sources.

Banks are required to report large cash transactions and other suspicious activities that might be signs of money laundering.3

The process of laundering money typically involves three steps: placement, layering, and integration.

• Placement surreptitiously injects the “dirty money” into the legitimate financial system.

• Layering conceals the source of the money through a series of transactions and bookkeeping tricks.

• In the final step, integration, the now-laundered money is withdrawn from the legitimate account to be used for whatever purposes the criminals have in mind for it.

Note that in real-life situations, this template may differ. Money laundering may not involve all three stages, or some stages could be combined or repeated several times.4

There are many ways to launder money, from the simple to the very complex. One of the most common techniques is to use a legitimate, cash-based business owned by a criminal organization. For example, if the organization owns a restaurant, it might inflate the daily cash receipts to funnel illegal cash through the restaurant and into the restaurant’s bank account. After that, the funds can be withdrawn as needed. These types of businesses are often referred to as “fronts.”

Variants of Money Laundering

One common form of money laundering is called smurfing (also known as “structuring”). This is where the criminal breaks up large chunks of cash into multiple small deposits, often spreading them over many different accounts, to avoid detection. Money laundering can also be accomplished through the use of currency exchanges, wire transfers, and “mules”—cash smugglers, who sneak large amounts of cash across borders and deposit them in foreign accounts, where money-laundering enforcement is less strict.

Other money-laundering methods include:

• Investing in commodities such as gems and gold that can be moved easily to other jurisdictions;

• Discreetly investing in and selling valuable assets such as real estate, cars, and boats;

• Gambling and laundering money at casinos;

• Counterfeiting; and

• Using shell companies (inactive companies or corporations that essentially exist on paper only).

Electronic Money Laundering

The Internet has put a new spin on the old crime. The rise of online banking institutions, anonymous online payment services, and peer-to-peer (P2P) transfers with mobile phones have made detecting the illegal transfer of money even more difficult. Moreover, the use of proxy servers and anonymizing software makes the third component of money laundering, integration, almost impossible to detect—money can be transferred or withdrawn with little or no trace of an Internet protocol (IP) address.

Money also can be laundered through online auctions and sales, gambling websites, and virtual gaming sites, where ill-gotten money is converted into gaming currency, then back into real, usable, and untraceable “clean” money.

The newest frontier of money laundering involves cryptocurrencies, such as Bitcoin. While not totally anonymous, they are increasingly being used in blackmail schemes, the drug trade, and other criminal activities due to their relative anonymity compared with more conventional forms of currency.5

AML laws have been slow to catch up to these types of cybercrimes, since most of the laws are still based on detecting dirty money as it passes through traditional banking institutions and channels.

Preventing Money Laundering

Governments around the world have stepped up their efforts to combat money laundering in recent decades, with regulations that require financial institutions to put systems in place to detect and report suspicious activity. The amount of money involved is substantial. According to the United Nations Office on Drugs and Crime, global money-laundering transactions account for roughly $800 billion to $2 trillion annually, or some 2% to 5% of global gross domestic product (GDP), although it is difficult to estimate the total amount due to the clandestine nature of money laundering.4

In 1989, the Group of Seven (G-7) formed an international committee called the Financial Action Task Force (FATF) in an attempt to fight money laundering on an international scale. In the early 2000s, its purview was expanded to combating the financing of terrorism.6

The United States passed the Bank Secrecy Act in 1970, requiring financial institutions to report certain transactions, such as cash transactions above $10,000 or any others that they deem suspicious, on a suspicious activity report (SAR) to the Department of the Treasury.13 The information that the banks provide to the Treasury Department is used by the Financial Crimes Enforcement Network (FinCEN), which can share it with domestic criminal investigators, international bodies, or foreign financial intelligence units.7

While these laws were helpful in tracking criminal activity, money laundering itself wasn’t made illegal in the United States until 1986, with the passage of the Money Laundering Control Act.8 Shortly after the Sept. 11, 2001, terrorist attacks, the USA Patriot Act expanded money-laundering efforts by allowing investigative tools designed for prevention of organized crime and drug trafficking to be used in terrorist investigations.1

The Association of Certified Anti-Money Laundering Specialists (ACAMS) offers a professional designation known as a Certified Anti-Money Laundering Specialist (CAMS). Individuals who earn CAMS certification may work as brokerage compliance managers, Bank Secrecy Act officers, financial intelligence unit managers, surveillance analysts, and financial crimes investigative analysts.9

Why is it important to combat money laundering?

Anti-money laundering (AML) seeks to deprive criminals of the profits from their illegal enterprises, thus eliminating the main motivation for them to engage in such nefarious activities. Illegal and dangerous activities, such as drug trafficking, people smuggling, terrorism funding, smuggling, extortion and fraud, endanger millions of people globally and impose tremendous social and economic costs upon society. As the proceeds of such activities are legitimized by money laundering, combating money laundering may result in a reduction in criminal activity and hence a significant benefit to society.

How are cryptocurrencies being used in money laundering?

The U.S. Financial Crimes Enforcement Network (FinCEN) noted in a June 2021 report that convertible virtual currencies (CVCs)—another term for cryptocurrencies—have grown to become the currency of choice in a wide range of online illicit activities.10 Apart from being the preferred form of payment for buying ransomware tools and services, online exploitative material, drugs, and other illegal goods online, CVCs are increasingly used to layer transactions and obfuscate the origin of money derived from criminal activity. Criminals use a number of money-laundering techniques involving cryptocurrencies, including “mixers” and “tumblers” that break the connection between an address (or crypto “wallet”) sending cryptocurrency and the address receiving it.

How is money laundering conducted in casinos?

One common form of money laundering in casinos is to buy chips from the casino with cash, and to receive checks in return for the chips from the casino, often without gambling at all or placing minimal bets.

What are some ways in which real estate is used for money laundering?

Some common methods used by criminals for money laundering through real estate transactions include undervaluation or overvaluation of properties, buying and selling properties in rapid succession, using third parties or companies that distance the transaction from the criminal source of funds, and private sales.

Outsourcing is the business practice of hiring a party outside a company to perform services or create goods that were traditionally performed in-house by the company's own employees and staff. Outsourcing is a practice usually undertaken by companies as a cost-cutting measure. As such, it can affect a wide range of jobs, ranging from customer support to manufacturing to the back office.

Outsourcing was first recognized as a business strategy in 1989 and became an integral part of business economics throughout the 1990s.1 The practice of outsourcing is subject to considerable controversy in many countries. Those opposed argue that it has caused the loss of domestic jobs, particularly in the manufacturing sector. Supporters say it creates an incentive for businesses and companies to allocate resources where they are most effective, and that outsourcing helps maintain the nature of free-market economies on a global scale.

KEY TAKEAWAYS

• Companies use outsourcing to cut labor costs, including salaries for their personnel, overhead, equipment, and technology.

• Outsourcing is also used by companies to dial down and focus on the core aspects of the business, spinning off the less critical operations to outside organizations.

• On the downside, communication between the company and outside providers can be hard, and security threats can amp up when multiple parties can access sensitive data.

• Some companies will outsource as a way to move things around on the balance sheet.

• Outsourcing employees, such as with 1099 contract workers, can benefit the company when it comes to paying taxes.

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Outsourcing

Understanding Outsourcing

Outsourcing can help businesses reduce labor costs significantly. When a company uses outsourcing, it enlists the help of outside organizations not affiliated with the company to complete certain tasks. The outside organizations typically set up different compensation structures with their employees than the outsourcing company, enabling them to complete the work for less money. This ultimately enables the company that chose to outsource to lower its labor costs.

Businesses can also avoid expenses associated with overhead, equipment, and technology.

In addition to cost savings, companies can employ an outsourcing strategy to better focus on the core aspects of the business. Outsourcing non-core activities can improve efficiency and productivity because another entity performs these smaller tasks better than the firm itself. This strategy may also lead to faster turnaround times, increased competitiveness within an industry, and the cutting of overall operational costs.

Companies use outsourcing to cut labor costs and business expenses, but also to enable them to focus on the core aspects of the business.

Examples of Outsourcing

Outsourcing's biggest advantages are time and cost savings. A manufacturer of personal computers might buy internal components for its machines from other companies to save on production costs. A law firm might store and back up its files using a cloud-computing service provider, thus giving it access to digital technology without investing large amounts of money to actually own the technology.

A small company may decide to outsource bookkeeping duties to an accounting firm, as doing so may be cheaper than retaining an in-house accountant. Other companies find outsourcing the functions of human resource departments, such as payroll and health insurance, as beneficial. When used properly, outsourcing is an effective strategy to reduce expenses, and can even provide a business with a competitive advantage over rivals.

Criticism of Outsourcing

Outsourcing does have disadvantages. Signing contracts with other companies may take time and extra effort from a firm's legal team. Security threats occur if another party has access to a company's confidential information and then that party suffers a data breach. A lack of communication between the company and the outsourced provider may occur, which could delay the completion of projects.

Special Considerations

Outsourcing internationally can help companies benefit from the differences in labor and production costs among countries. Price dispersion in another country may entice a business to relocate some or all of its operations to the cheaper country in order to increase profitability and stay competitive within an industry. Many large corporations have eliminated their entire in-house customer service call centers, outsourcing that function to third-party outfits located in lower-cost locations.

What Is Outsourcing?

First seen as a formal business strategy in 1989, outsourcing is the process of hiring third parties to conduct services that were typically performed by the company. Often, outsourcing is used so that a company can focus on its core operations. It is also used to cut costs on labor, among others. While privacy has been a recent area of controversy for outsourcing contractors, it has also drawn criticism for its impact on the labor market in domestic economies.

What Is an Example of Outsourcing?

Consider a bank that outsources its customer service operations. Here, all customer-facing inquiries or complaints with concern to its online banking service would be handled by a third party. While choosing to outsource some business operations is often a complex decision, the bank determined that it would prove to be the most effective allocation of capital, given both consumer demand, the specialty of the third-party, and cost-saving attributes. 

What Are the Disadvantages of Outsourcing?

The disadvantages of outsourcing include communication difficulties, security threats where sensitive data is increasingly at stake, and additional legal duties. On a broader level, outsourcing may have the potential to disrupt a labor force. One example that often comes to mind is the manufacturing industry in America, where now a large extent of production has moved internationally. In turn, higher-skilled manufacturing jobs, such as robotics or precision machines, have emerged at a greater scale.

The Bottom Line

While outsourcing can be advantageous to an organization that values time over money, some downsides can materialize if the organization needs to retain control. Outsourcing manufacturing of a simple item like clothing will carry much less risk than outsourcing something complex like rocket fuel or financial modeling. Businesses looking to outsource need to adequately compare the benefits and risks before moving forward.

A stock-keeping unit (SKU) is a scannable bar code, most often seen printed on product labels in a retail store. The label allows vendors to automatically track the movement of inventory. The SKU is composed of an alphanumeric combination of eight-or-so characters. The characters are a code that track the price, product details, and the manufacturer. SKUs may also be applied to intangible but billable products, such as units of repair time in an auto body shop or warranties.

KEY TAKEAWAYS

• A stock-keeping unit (SKU) is a scannable bar code to help vendors automatically track the movement of inventory.

• SKUs are also used for units of repair time units, services, and warranties.

• SKUs help vendors determine which products require reordering and provide sales data.

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Stock Keeping Unit (SKU)

Understanding Stock Keeping Units (SKUs)

SKUs are used by stores, catalogs, e-commerce vendors, service providers, warehouses, and product fulfillment centers to track inventory levels. Scannable SKUs and a POS system mean that it is easy for managers to determine which products need to be restocked. When a customer buys an item at the point-of-sale (POS), the SKU is scanned and the POS system automatically removes the item from the inventory as well as recording other data such as the sale price. SKUs should not be confused with model numbers, although businesses may embed model numbers within SKUs.

Image by Sabrina Jiang © Investopedia 2020 

By adding SKUs to every product, store owners can easily track the quantity of available products. Owners can create threshold limits to let them know when new purchase orders must be made.

Businesses create different SKUs for its goods and services. For example, a store that sells shoes creates internal SKUs that show a product’s details, such as color, size, style, price, manufacturer, and brand. For example, the SKU for purple Ugg boots in the Bailey Bow style, size 6, may read "UGG-BB-PUR-06."

The Importance of Stock Keeping Units

SKUs let shoppers compare characteristics of similar items. For example, when a shopper buys a specific DVD, online retailers might display similar movies purchased by other customers based on SKU information. This method may trigger additional purchases by the customer, thereby increasing a company’s revenue. SKUs also allow data to be collected on sales. For example, a store can see which items are selling well and which are not based on the scanned SKUs and the POS data.

Stock Keeping Units vs. Universal Product Codes

Because companies internally create SKUs to track inventory, the SKUs for identical products vary among businesses. Different SKUs help retailers design advertising campaigns without interference from other vendors.

For example, if a company provides the SKU to advertise a certain discounted refrigerator, shoppers cannot easily view the same refrigerator at other sellers based on the SKU alone. This stops competitors from matching advertised prices and poaching customers. In contrast, universal product codes (UPCs) are identical regardless of which business is selling the items.

Example of SKUs in the Modern World

SKUs are making the shopping experience more efficient than ever before. For example, when shoe shopping in the past, clerks would have had to visually scour the back stockroom and hunt for a specific model of shoes in your correct size. Today, many retailers are equipped with portable scanners enabling salespeople to check back-of-the-store inventory by simply scanning a floor sample. This is one of the many benefits of the modern-day SKU system.

Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, affluence, and business success. They are often preppy in appearance and like to show off their success by their style and possessions.

KEY TAKEAWAYS

• The term yuppie originated in the 1980s and is used to refer to young urban professionals who are successful in business and considerably affluent.

• Some credit writer Joseph Epstein with using the term while others point to journalist Dan Rottenberg's Chicago magazine article.

• It is difficult to identify modern yuppies because modern society has doled out wealth to various groups of people rather than a specific set of people with similar characteristics.

Understanding Yuppies

Coined in the 1980s, the term yuppie was used as a derogatory title for young business people who were considered arrogant, undeservedly wealthy, and obnoxious.1 Yuppies were often associated with wearing high fashion clothing, driving BMWs, and gloating about their successes. The term has become less of a stereotype and now promotes the image of an affluent professional.

Yuppies tend to be educated with high-paying jobs, and they live in or near large cities. Some typical industries associated with yuppies include finance, tech, academia, and many areas in the arts, especially those associated with liberal thinking and style.

History of the Term Yuppie

There is some debate over who first coined the term yuppie, but many attribute this to Joseph Epstein, writer and former editor of The American Scholar.2 Others credit journalist Dan Rottenberg with coining the term in 1980 an article titled "About That Urban Renaissance..." for Chicago magazine. Rottenberg describes the gentrification of Chicago's downtown by upwardly mobile young professionals rebelling against suburbia. "The Yuppies seek neither comfort nor security, but stimulation, and they can find that only in the densest sections of the city," he wrote.3

Linguistically, the term was an evolution, starting from the word "hippie," which 20 years earlier was a label attached to someone considered "hip" to the current culture. That word morphed into "yippie"—counterculture advocates associated with the Youth International Party.

At nearly the same time, a parody of an American stereotype of the "country-club/prep school culture" called The Preppy Handbook made The New York Times bestseller list. "Yuppie" was the mash-up of all of these moments in the young adults in America, each a reflection of their time.

Yippies, in contrast to yuppies, were affiliates of the Youth International Party, a counterculture group that emerged in the late 1960s. The term continued to grow throughout the 1980s as it was used in more newspaper and magazine articles.

After the 1987 stock market crash, the term yuppie became less political and gained more of the social implications it has today. Although its usage declined in the 1990s, it has since come back into the United States lexicon. It has been used and cited in articles, songs, movies, and other pop culture media. To name a few, the term has appeared in the novel and film Fight Club, the movie American Psycho, the satirical blog "Stuff White People Like" and the Tom Petty song "Yer So Bad."

The term yuppie isn't confined only to the United States—other countries, such as China, Russia, and Mexico, have their variations of yuppies that generally also carry the hallmark connotation of young, higher-class professionals. The term tends to spread and thrive in prospering economies.

Modern Yuppies

In the 21st century, the term takes on new meaning while retaining the basic tenets of original yuppies. For example, due to the internet and growing reliance on electronic communication, the term yuppie could refer to a Silicon Valley tech worker that doesn't necessarily have the same social skills as the original yuppie, but still works for a prestigious company and makes a lot of money.

This can make it harder to define yuppies since it might not be obvious at first glance that these people have glamorous careers. Perhaps, as a result, the term yuppie isn't used as widely as it was in the 1980s and early 1990s.

A 2015 article in The New York Times made the case that the all-encompassing definition of yuppies had fragmented.4

Micro-yuppies abounded. These yuppies profess allegiance to lifestyles, such as nature-based, or professional communities, such as technology executives, or even online communities, such as gaming. Hipsters, who mock the consumption culture fostered by modern society, have replaced earlier yuppies. However, the irony of the situation is that they participate in society actively through their choices.

An externality is a cost or benefit caused by a producer that is not financially incurred or received by that producer. An externality can be both positive or negative and can stem from either the production or consumption of a good or service. The costs and benefits can be both private—to an individual or an organization—or social, meaning it can affect society as a whole.

Externalities by nature are generally environmental, such as natural resources or public health. For example, a negative externality is a business that causes pollution that diminishes the property values or health of people in the surrounding area. A positive externality includes actions that reduce transmission of disease or avoids the use of lawn treatments that runoff to rivers and thus contribute to excess plant growth in lakes. Externalities are different from donations of parkland or open-source software.

Understanding Externalities

Externalities occur in an economy when the production or consumption of a specific good or service impacts a third party that is not directly related to the production or consumption of that good or service.

Almost all externalities are considered to be technical externalities. Technical externalities have an impact on the consumption and production opportunities of unrelated third parties, but the price of consumption does not include the externalities. This exclusion creates a gap between the gain or loss of private individuals and the aggregate gain or loss of society as a whole.

The action of an individual or organization often results in positive private gains but detracts from the overall economy. Many economists consider technical externalities to be market deficiencies, and this is the reason people advocate for government intervention to curb negative externalities through taxation and regulation.

Externalities were once the responsibility of local governments and those affected by them. So, for instance, municipalities were responsible for paying for the effects of pollution from a factory in the area while the residents were responsible for their healthcare costs as a result of the pollution. After the late 1990s, governments enacted legislation imposing the cost of externalities on the producer. This legislation increased costs, which many corporations passed on to the consumer, making their goods and services more expensive.

Externality

Positive and Negative Externalities

Most externalities are negative. Pollution is a well-known negative externality. A corporation may decide to cut costs and increase profits by implementing new operations that are more harmful to the environment. The corporation realizes costs in the form of expanding operations but also generates returns that are higher than the costs.

However, the externality also increases the aggregate cost to the economy and society making it a negative externality. Externalities are negative when the social costs outweigh the private costs.

Some externalities are positive. Positive externalities occur when there is a positive gain on both the private level and social level. Research and development (R&D) conducted by a company can be a positive externality. R&D increases the private profits of a company but also has the added benefit of increasing the general level of knowledge within a society.

Similarly, the emphasis on education is also a positive externality. Investment in education leads to a smarter and more intelligent workforce. Companies benefit from hiring employees who are educated because they are knowledgeable. This benefits employers because a better-educated workforce requires less investment in employee training and development costs.

Overcoming Externalities

There are solutions that exist to overcome the negative effects of externalities. These can include those from both the public and private sectors.

Taxes are one solution to overcoming externalities. To help reduce the negative effects of certain externalities such as pollution, governments can impose a tax on the goods causing the externalities. The tax, called a Pigovian tax—named after economist Arthur C. Pigou, sometimes called a Pigouvian tax—is considered to be equal to the value of the negative externality. This tax is meant to discourage activities that impose a net cost to an unrelated third party. That means that the imposition of this type of tax will reduce the market outcome of the externality to an amount that is considered efficient.

Subsidies can also overcome negative externalities by encouraging the consumption of a positive externality. One example would be to subsidize orchards that plant fruit trees to provide positive externalities to beekeepers.

Governments can also implement regulations to offset the effects of externalities. Regulation is considered the most common solution. The public often turns to governments to pass and enact legislation and regulation to curb the negative effects of externalities. Several examples include environmental regulations or health-related legislation.

Examples of variable costs include a manufacturing company's costs of raw materials and packaging—or a retail company's credit card transaction fees or shipping expenses, which rise or fall with sales. A variable cost can be contrasted with a fixed cost.

KEY TAKEAWAYS A variable cost is an expense that changes in proportion to production output or sales. When production or sales increase, variable costs increase; when production or sales decrease, variable costs decrease. Variable costs stand in contrast to fixed costs, which do not change in proportion to production or sales volume. 1:39 Variable Costs Understanding Variable Costs The total expenses incurred by any business consist of variable and fixed costs. Variable costs are dependent on production output or sales. The variable cost of production is a constant amount per unit produced. As the volume of production and output increases, variable costs will also increase. Conversely, when fewer products are produced, the variable costs associated with production will consequently decrease.

Examples of variable costs are sales commissions, direct labor costs, cost of raw materials used in production, and utility costs.

Variable costs are usually viewed as short-term costs as they can be adjusted quickly. How to Calculate Variable Costs The total variable cost is simply the quantity of output multiplied by the variable cost per unit of output:

Total Variable Cost = Total Quantity of Output X Variable Cost Per Unit of Output

Variable Costs vs. Fixed Costs Fixed costs are expenses that remain the same regardless of production output. Whether a firm makes sales or not, it must pay its fixed costs, as these costs are independent of output.

Examples of fixed costs are rent, employee salaries, insurance, and office supplies. A company must still pay its rent for the space it occupies to run its business operations irrespective of the volume of products manufactured and sold. If a business increased production or decreased production, rent will stay exactly the same. Although fixed costs can change over a period of time, the change will not be related to production, and as such, fixed costs are viewed as long-term costs.

There is also a category of costs that falls between fixed and variable costs, known as semi-variable costs (also known as semi-fixed costs or mixed costs). These are costs composed of a mixture of both fixed and variable components. Costs are fixed for a set level of production or consumption and become variable after this production level is exceeded. If no production occurs, a fixed cost is often still incurred.

In general, companies with a high proportion of variable costs relative to fixed costs are considered to be less volatile, as their profits are more dependent on the success of their sales.

Example of a Variable Cost Let’s assume that it costs a bakery $15 to make a cake—$5 for raw materials such as sugar, milk, and flour, and $10 for the direct labor involved in making one cake. The table below shows how the variable costs change as the number of cakes baked vary.

1 cake

2 cakes

7 cakes

10 cakes

0 cakes

Cost of sugar, flour, butter, and milk

$5

$10

$35

$50

$0

Direct labor

$10

$20

$70

$100

$0

Total variable cost

$15

$30

$105

$150

$0

As the production output of cakes increases, the bakery’s variable costs also increase. When the bakery does not bake any cake, its variable costs drop to zero.

Fixed costs and variable costs comprise the total cost. Total cost is a determinant of a company’s profits, which is calculated as:

\begin{aligned} &\text{Profits} = Sales - Total~Costs\ \end{aligned} ​

Profits=Sales−Total Costs ​

A company can increase its profits by decreasing its total costs. Since fixed costs are more challenging to bring down (for example, reducing rent may entail the company moving to a cheaper location), most businesses seek to reduce their variable costs. Decreasing costs usually means decreasing variable costs.

If the bakery sells each cake for $35, its gross profit per cake will be $35 - $15 = $20. To calculate the net profit, the fixed costs have to be subtracted from the gross profit. Assuming the bakery incurs monthly fixed costs of $900, which includes utilities, rent, and insurance, its monthly profit will look like this:

Number Sold Total Variable Cost Total Fixed Cost Total Cost Sales Profit 20 Cakes $300 $900 $1,200 $700 $(500) 45 Cakes $675 $900 $1,575 $1,575 $0 50 Cakes $750 $900 $1,650 $1,750 $100 100 Cakes $1,500 $900 $2,400 $3,500 $1,100 A business incurs a loss when fixed costs are higher than gross profits. In the bakery’s case, it has gross profits of $700 - $300 = $400 when it sells only 20 cakes a month. Since its fixed cost of $900 is higher than $400, it would lose $500 in sales. The break-even point occurs when fixed costs equal the gross margin, resulting in no profits or loss. In this case, when the bakery sells 45 cakes for total variable costs of $675, it breaks even.

A company that seeks to increase its profit by decreasing variable costs may need to cut down on fluctuating costs for raw materials, direct labor, and advertising. However, the cost cut should not affect product or service quality as this would have an adverse effect on sales. By reducing its variable costs, a business increases its gross profit margin or contribution margin.

The contribution margin allows management to determine how much revenue and profit can be earned from each unit of product sold. The contribution margin is calculated as:

\begin{aligned} &\text{Contribution~Margin} = \dfrac{Gross~Profit}{Sales}=\dfrac{ (Sales-VC)}{Sales}\&\textbf{where:}\&VC = \text{Variable Costs}\ \end{aligned} ​

Contribution Margin=

Sales Gross Profit ​

Sales (Sales−VC) ​

where: VC=Variable Costs ​

The contribution margin for the bakery is ($35 - $15) / $35 = 0.5714, or 57.14%. If the bakery reduces its variable costs to $10, its contribution margin will increase to ($35 - $10) / $35 = 71.43%. Profits increase when the contribution margin increases. If the bakery reduces its variable cost by $5, it would earn $0.71 for every one dollar in sales.

What Are Some Examples of Variable Costs? Common examples of variable costs include costs of goods sold (COGS), raw materials and inputs to production, packaging, wages, and commissions, and certain utilities (for example, electricity or gas that increases with production capacity).

How Do Fixed Costs Differ From Variable Costs? Variable costs are directly related to the cost of production of goods or services, while fixed costs do not vary with the level of production. Variable costs are commonly designated as COGS, whereas fixed costs are not usually included in COGS. Fluctuations in sales and production levels can affect variable costs if factors such as sales commissions are included in per-unit production costs. Meanwhile, fixed costs must still be paid even if production slows down significantly.

How Can Variable Costs Impact Growth and Profitability? If companies ramp up production to meet demand, their variable costs will increase as well. If these costs increase at a rate that exceeds the profits generated from new units produced, it may not make sense to expand. A company in such a case will need to evaluate why it cannot achieve economies of scale. In economies of scale, variable costs as a percentage of overall cost per unit decrease as the scale of production ramps up.

Is Marginal Cost the Same as Variable Cost? No. Marginal cost refers to how much it costs to produce one additional unit. The marginal cost will take into account the total cost of production, including both fixed and variable costs. Since fixed costs are static, however, the weight of fixed costs will decline as production scales up.