Chapter 13: Saving, investment, and the financial system

If a reform of the tax laws encouraged greater investment,

RESULT WOULD BE HIGHER INTEREST RATES AND GREATER SAVING

write savings equation in a way that denotes government tax revenue and social security pay out

S = (Y - T - C) + (T - G), BUT THE T'S CANCEL OUT SO IT IS THE SAME AS Y - C - G

what is a bond?

a certificate of indebtedness

what is stock?

a claim to partial ownership in a firm

what does the term crowding out mean?

a decrease in investment that results from government borrowing

what is a sale of stock called? what is a sale of bonds called?

equity finance, debt finance

what are financial markets?

financial institutions through which savers can directly provide funds to borrowers?

what are financial intermediaries?

financial institutions through which savers can indirectly provide funds to borrowers

what does high investment mean?

greater capital accumulation and more rapid economic growth

if firms had an incentive to increase investment at any interest rate, quantity of loanable funds demanded would be...

higher at any given interest rate. (graph)

what does a budget surplus do?

increases the supply of loanable funds, reduces interest rate, and stimulates investment

when the government reduces national saving by running a budget deficit, effect on interest rates/investment...

interest rates rise, investment falls

what is the difference between saving and investment?

investment: buying a home, purchasing new capital saving: buying stock/bond, depositing in a bank

what increases demand for loanable funds?

low interest rate. High interest rate makes borrowing more expensive

If a reform of tax laws encouraged greater saving, the result would be....

lower interest rates and greater investment

what is the source of the supply of loanable funds?

national saving = private + public saving

what is a closed economy?

one that does not interact with other economies, does not engage in international trade/borrowing/lending.

supply of loanable funds comes from:

people who have extra income they want to save and lend out

where does the demand for loanable funds come from?

people who want to invest, investment

What happens to supply curve when the government runs a deficit?

public saving is negative, and reduces national saving, reducing supply of loanable funds, shifts supply curve to the left

DOES SUPPLY/DEMAND OF LOANABLE FUNDS DEPEND ON NOMINAL OR REAL INTEREST RATE?

real, because it more accurately reflects the real return to saving and the real cost of borrowing

what does the policy of taxing interest income do?

reduces future payoff from current saving and reduces incentive for people to save

what does a budget deficit do?

reduces supply of loanable funds, drives up interest rate, crowds out borrowers trying to finance capital investment

if (Y - C - G) = savings, then

savings = investment

what happens when equilibrium interest rate is low?

shortage of funds, quantity supplied would be less than quantity demanded, would encourage lenders to raise interest rate

what does the financial market entail

stock and bond market

what is the market for loanable funds governed buy

supply and demands

saving represents

supply of loanable funds

what is the job of the bank, primarily?

take in deposits from people who want to save and use these deposits to make loans to people who want to borrow. pay interest to depositors and charge borrowers slightly higher interest rates on their loans. [

what is an investment tax credit?

tax advantage to any firm building new factor, etc.

what is the financial system?

the group of institutions in the economy that help to match one person's saving with another person's investment

what is private saving?

the income that households have left over after paying for taxes and consumption

what is the market for loanable funds?

the market in which those who want to save supply funds and those who want to borrow to invest demand funds

what is interest rate?

the price of a loan, who much borrowers pay for loans and the amount that lenders receive on their saving

What is the one interest rate for loanable funds?

the return to saving and the cost of borrowing

what is public saving?

the tax revenue the government has left after paying for its spending?

what is national saving?

the total income in the economy that remains after paying for consumption and government purchases

what happens when borrowers can't pay back their bonds?

they default on loans, sometimes done through bankrupcy. Higher default, higher interest rate.

what role do banks play in the economy?

they facilitate purchases of goods and services by allowing people to write checks against their deposits, and access those deposits with debit cards: create a medium of exchange to use in transaction.

why do savers supply their money to the financial system?

with the expectation that they will get it back with interest at a later date

what would happen if a policy was enacted that would save some of people's savings from taxation? concerning market for loanable funds

would alter incentive for houses to save at any given interest rate, and affect quantity of loanable funds supplied at each interest rate. Supply of loanable funds would shift. Demand would be the same, because tax change would not affect amount that borrowers want to borrow. Supply of funds would increase, cost of borrowing would be lower.

investment represents

demand for loanable funds

why do borrowers borrow?

demand money with knowledge they'll be required to pay it back with interest at a later dat

slope of loanable funds supply and demand?

demand slopes down, supply slopes up

what do higher interest rates do?

encourage saving, and discourage borrowing for investment

what increases supply of loanable funds?

High interest rate

what is the equation for national saving?

I = Y - C - G

equation for private saving

PRIVATE = Y - T - C

equation for public saving

PUBLIC = T - G

what is a budget deficit?

a shortfall of tax revenue from government spending, when T is less than G

what are loanable funds?

all income that people have chosen to save and lend out, rather than use for their own consumption, and to the amount that investors have chosen to borrow to fund new investment projects

what is an identity?

an equation that must be true because of the way the variables in the equation are defined.

what is the equation/what is a budget surplus?

an excess of tax revenue over government spending, when T exceeds G in equation T - G

what is a mutual fund?

an institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds