Macroeconomics Ch. 13: Saving, Investment, and the Financial System – Flashcards
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Investment
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Purchase of capital goods
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Is investment in economics the same as investment in accounting?
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No
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How many times are dividends taxed?
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Twice
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Financial System
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The group of institutions that help match the saving of one person with the investment of another
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Financial Market
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Institutions in which savers can DIRECTLY provide funds to borrowers
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Bond
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A certificate of indebtedness
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Stock
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A claim to partial ownership in a firm
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Creditor
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Owner of a bond
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Partial Owner
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Owner of a stock
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Primary Market
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Stock or bond bought directly from company -Company directly gets money
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Secondary Market
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The previous owner gets the money (We want to sell our stock or bond in the secondary market)
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Why shouldn't you put all your eggs into one basket?
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You will face high risk and low rewards
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Should you put your company's stock in your 401k?
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No!
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Financial Intermediaries
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Institutions through which savers can INDIRECTLY provide funds to borrowers (ex: bank)
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Mutual Funds
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Institutions that sell shares to the public and use the proceeds to buy portfolios of stock and bonds (required by law that a company tells the truth about their mutual fund) -If we don't have enough $ and want to diversify risks, we buy mutual funds -comprised of at least 15 companies -The purpose is to diversify risk -Club of investors pull their resources to diversify risk
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Net Savers
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Households
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Net Borrowers
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Businesses
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How do banks make money?
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By issuing loans
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What is the purpose of Mutual Funds?
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To diversify risks
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What is U.S.'s unemployment?
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~7.7%
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What causes unemployment?
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The housing bubble
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6 Elements of Financial Crises
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1. Large decline in some asset prices 2. Insolvencies at financial institutions 3. Decline in confidence in financial institutions 4. Credit Crunch 5. Economic Downturn 6. Vicious Circle
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Large decline in some asset prices
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2008-2009: Housing prices fell 30%
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Insolvencies at financial institutions
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2008-2009: Banks and other institutions failed when many homeowners stopped paying their mortgages
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Decline in confidence in financial institutions
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2008-2009: Customers with uninsured deposits began pulling their funds out of financial institutions
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Credit Crunch
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2008-2009: Borrowers unable to get loans because troubled lenders not confident in borrowers' credit-worthiness
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Economic Downturn
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2008-2009: Failing financial institutions and a fall in investment caused GDP to fall and unemployment to rise
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Vicious Circle
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2008-2009: The downturn reduced profits and asset values, which worsened the crisis
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Do you ever want to tax people on their savings?
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No
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Will the economy fix itself?
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Yes, if you give it time.
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Do we want to avoid losing?
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Yes
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When do we want to economy to get better?
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Now!
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Private Saving
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The portion of household's income that is not sued for consumption or paying taxes =Y-T-C
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Public Saving
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Tax revenues minus government spending =T-G
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National Saving
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The portion of national income that is not sued for consumption or government purchases -Private Saving + Public Saving =(Y-T-C)+(T-G) =Y-C-G
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National Saving = ?
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Investment
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Y=
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Income (taxes we have to pay)
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T=
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Taxes (tax revenue)
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C=
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Consumption (what we spend)
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G=
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Government spending
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GDP Formula
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Y=C+I+G+NX
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Closed Economy Formula
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Y=C+I+G
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Closed Economy
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When there is no Net Export
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What does Saving equal in a Closed Economy?
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Investment
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National Savings Formula
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I=Y-C-G I=(Y-T-C)+(T-G)
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Budget Surplus
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An excess of tax revenue over government spending =T-G =Public saving
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Budget Deficit
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A shortfall of tax revenue from government spending =G-T = -(Public Saving)
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Taxes= ?
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Government Spending - Public Saving
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Investment= ?
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National Saving
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Private Saving
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The income remaining after households pay their taxes and pay for consumption
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What do households do with savings?
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-Buy corporate bonds or equities -Purchase a certificate of deposit at the bank -Buy shares of a mutual fund -Let accumulate in saving or checking accounts
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Investment
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The purchase of new capital
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Examples of Investment
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-GM spends $250 million to build a new factory in Michigan -You buy $5000 worth of computer equipment for your business -Your parents spend $300,000 to have a new house built
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What is the source of supply of loanable funds?
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Savings
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What is the source of demand of loanable funds?
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Investment
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Does a repeal to an investment tax credit increase or decrease quantity demanded?
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Decrease
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In economics, is investment the purchase of stocks and bonds?
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No!
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What two things does a supply-demand model of the financial system help us understand?
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1. How the financial system coordinates saving and investment 2. How govt policies and other factors affect saving, investment, the interest rate
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Characteristics with only one financial market
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-all savers deposit their saving in this market -all borrowers take out loans from this market -there is one interest rate, which is both the return to saving and the cost of borrowing
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Positive Public Savings
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Budget surplus -adds to national saving and the supply of loanable funds
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Negative Public Savings
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Budget deficit -reduces national saving and the supply of loanable funds
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Who are net savers?
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Households
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Who are net spenders?
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Businesses
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Does positive public savings increase or decrease national saving and the supply of loanable funds?
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Increase
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Does negative public savings increase or decrease national saving and the supply of loanable funds?
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Decrease
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Does an increase in interest rate increase or decrease the quantity of loanable funds supplied?
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Increase
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What does a fall in the interest rate reduce?
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Reduces the cost of borrowing
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Does a decrease in interest rate increase or decrease the quantity of loanable funds demanded?
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Increase
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What are the axis labeled in the supply/demand graph for the market for loanable funds?
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x axis: loanable funds y axis: interest rate
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Why does the interest rate adjust?
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Adjusts to equate supply and demand
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What does the equilibrium quantity of loanable funds equal?
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Equals the equilibrium investment and equilibrium saving
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3 Steps for Saving Incentives
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1. Tax incentives for saving increase the supply of loanable funds 2. ...which reduces the equilibrium interest rate 3. ...and increases the equilibrium quantity of loanable funds
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3 Steps for Investment Incentives
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1. An investment tax credit increases the demand for loanable funds 2. ...which raises the equilibrium interest rate 3. ...and increases the equilibrium quantity of loanable funds
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3 Steps when the govt runs a budget deficit
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1. A budget deficit reduces national saving and the supply of loanable goods 2. ...which increases the equilibrium interest rate 3. ...and decreases the equilibrium quantity of loanable funds and investment
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3 steps when the govt runs a budget surplus
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1. A budget surplus increases national saving and the supply of loanable goods 2. ...which decreases the equilibrium interest rate 3. ...and increases the equilibrium quantity of loanable funds and investment
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Does an increase in budget deficit cause an increase or decrease in investment?
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Decrease in investment
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Why does an increase in budget deficit cause a fall in investment?
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The govt borrows to finance its deficit, leaving less funds available for investment
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Crowing Out
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The govt borrows to finance its deficit, leaving less funds available for investment -when government must finance its spending with taxes and/or with deficit spending, leaving businesses with less money and effectively "crowding them out."
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Is investment important for long-term or short-term economic growth?
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Long-term
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Do budget deficits increase or decrease the economy's growth rate and future standard of living?
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Decrease
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How does the govt finance deficits?
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By borrowing (selling govt bonds)
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Do persistant deficits lead to a rising or falling govt debt?
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Rising govt debt
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3 Characteristics of Bonds
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1. It has a coupon rate 2. It has a face value 3. It has a maturity
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Financial System
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the group of institutions in the economy that help to match one person's saving with another person's investment
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Financial Markets
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financial institutions through which savers can directly provide funds to borrowers
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Bond
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a certificate of indebtedness
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Stock
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a claim to partial ownership in a firm
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Financial Intermediaries
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financial institutions through which savers can indirectly provide funds to borrowers
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Mutual Fund
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an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds
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National Saving (saving)
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the total income in the economy that remains after paying for consumption and government purchases
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Private Saving
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the income that households have left after paying for taxes and consumption
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Public Saving
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the tax revenue that the government has left after paying for its spending
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Budget Surplus
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an excess of tax revenue over government spending
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Budget Deficit
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a shortfall of tax revenue from government spending
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Market for Loanable Funds
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the market in which those who want to save supply funds and those who want to borrow to invest demand funds
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Crowding Out
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a decrease in investment that results from government borrowing
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