Chapter 29- Saving Investment, and the Financial System

What is the "lifecycle" theory of savings?

By borrowing, saving, and dissaving, workers can smooth their consumption path over a lifetime, improving their overall satisfaction.

Banks earn profit by ...

Charging more for their loans than they pay for the savings

Impatience is reflected not just in savings but in any economic situation where people must compare _______________ over time

Cost and benefits

Periodic payments are also known as ...

Coupon payments

Simple psychological changes, combined with _______________ and ____________ can change how much people save for their retirement.

Effective marketing; Promotion

When interest rates go up, bond prices _________

Fall

Businesses borrow when they expect that the return on their investment will be __________ than the cost of the loan

Greater If the interest rate is 10%, businesses will borrow only if they expect their invest will return more than 10%

If a risky company wished to borrow money, it has to promise a __________ rate of interest because lenders will demand to be compensated for a greater risk of default.

Higher

What is the interest rate?

How much savers are paid to save

Define saving

Income that is not spent on consumption goods

An _________ in the supply of savings increases savings and __________ interest rate

Increase; Reduces

An investment in tax credit _____________ investment demand, which ___________ the quantity of savings and the interest rate

Increases; Increases

What are financial intermediaries

Institutions such as banks, bond markets, and stock markets that reduce the costs of moving funds from savers to borrowers and investors

The ________ adjusts to equalize savings and borrowings in the same way and for the same reasons that the price of oil adjusts to balance the supply and demand for oil

Interest rate

The more impatient a person, the more likely that person's saving rate will be _____

Low

The supply of savings and the demand to borrow can be put together to find an equilibrium in what economists call the _______________

Market for loanable funds

Marketing matters!!! Often individuals save ________ if savings is presented as the natural or default alternative

More

Higher interest rates usually call forth _______ savings

More The higher the interest rate the greater quantity saved

Interest rates and bond prices move in ....

Opposite directions

Why do people want to borrow?

People borrow to smooth their consumption path and to finance large investments.

_______________ on interest rates can also cause the loanable funds market to malfunction

Price controls

Instead of borrowing from a bank, well-known corporations can borrow directly from the __________

Public

What is the formula for rate of return?

Rate of return for a zero-coupon bond = Face value - Price / Price x 100

Financial intermediaries _____________ the costs of moving funds from savers to borrowers and help mobilize savings toward productive uses

Reduce

Greater risk can ___________ the supply of funds to the market as a whole

Reduce

When interest rates go down, bond prices ______

Rise

Economic growth cannot occur without _______

Savings

What are stocks?

Shares of ownership in a corporation

With a _________ of savings, demanders would bid the interest rate up as they competed to borrow

Shortage

What is collateral?

Something of value that helps to secure a loan; if the borrower defaults, ownership of the collateral transfers to the lender

_____________ puts the demand to borrow and save together

The "lifecycle" theory of savings

The quantity of funds that people want to borrow also depends on ...

The cost of the loan, or the interest rate

What does crowded out mean?

The decrease in private consumption and investment that occurs when the government borrows more; also, the decrease in private spending that occurs when government increases spending

What is time preference?

The desire to have goods and services sooner rather than later (all else being equal).

What is initial public offering?

The first instance of a corporation selling stock to the public in order to raise capital

The demand to borrow follows the law of demand. Explain

The lower the interest rate, the greater the quantity of funds demanded for investment as well as for other purposes.

What is the market for loanable funds?

The market where suppliers of loanable funds (savers) trade with the demanders of loanable funds (borrowers), thereby determining the equilibrium interest rate.

What is an arbitrage principle?

The practice of taking advantage of price differences for the same good in different markets by buying low in one market and selling high in another market

Define investment

The purchase of new capital goods; private spending on tools, plant, and equipment used to produce future output.

In equilibrium, the quantity of funds supplied equals ...

The quantity of funds demanded

True or False: Businesses borrow to finance large projects

True!!!!

True or False: The way economist define investment is not the same as the way a stockbroker defines investment

True!!!! If Starbucks buys new espresso machines for its stores, that is investment. If John buys stocks in Starbucks, that is not investment.

Bridges between savers and borrows can be broken in three ways:

1. Reducing the supply of savings 2. Raising he costs of intermediation 3. Reducing the effectiveness of lending

What are four of the major factors that determines the supply of savings?

1. Smoothing Consumption 2. Impatience 3. Marketing and Psychological Factors 4. Interest Rates

What is behavioral economics?

A new and growing field within economics that combines economics, psychology, and neurology to study how people make decisions and how they can be helped to overcome biases in decision making.

What is default risk?

A risk that when the payments is due, the borrower will not be able to pay

What is a bond?

A sophisticated IOU that documents who owes how much and when payments must be made