EC 202 Craig Test 2

Commercial banks

"main street" banks, which take deposits and engage in commercial banking -more focus on commercial banks

Investment bank

"wall street" banks, which engage in trading activities (often through hedge funds) and underwriting securities

For a closed economy - i.e. an economy in which there are no international transactions - suppose for the current fiscal year that GDP is 411 trillion, consumption is $7 trillion, tax revenues equal $3 trillion, and the government runs a budget deficit of $1 trillion. Assuming transfer payments are zero, it follows that private saving is ____, and public saving is ___.

$1 trillion.; -$1 trillion

Suppose a 30 year bond with a $10000 FV pays 0%annual coupon (at the end of the year), has 1 year left to maturity, and has a discount rate of 0%. What is the current market price of the bond?

$10,000

Bond price =

(Coupon 1/(1+i)) + (Coupon 2/(1+i)^2) + (Coupon N/(1+i)^n) + (Face Value/(1+i)^n) i=discount rate

How elasticity of supply affects the size of deadweight loss

(a) the supply curve is relatively inelastic: quantity supplied responds only slightly to changes in price (b) supply curve is relatively elastic: quantity supplied responds substantially to changes in price -deadweight loss is larger when the supply/demand curve is more elastic

Close economy

(assumed economy) doesn't interact with other economies - NX = 0 -Y = C + I + G

Yield =

(coupon payment/price) -market based interest rate -*prices and yields move inversely*

Two important variables of price:

-"credit" / "default risk" -"inflation" risk -Whenever something bad (having a hard time paying your debts) happens to the issuer, the credit/default risk goes up -having a high default risk means that you won't see your money again -this is why many countries can't borrow in their own currencies

Raising funds in established firms

-"retained earnings" - rather than distributing (after-tax) profits to owners in the form of dividends, the for-profit firms keep the profits for investment -stock: the firm extends ownership to new stock holders -debt: the firm or government borrows the money either from a bank or, more commonly for governments, via the bond market

Suppose the US congress fail to pass a budget, thus 'shutting down the government' and fails to authorize an increase in the national debt ceiling, while simultaneously continuing to run $1 trillion annual budget deficit by continuing to pay federal entitlements. Determine the movement (increase/decrease) in bond price and yield.

-Bad signal, demand for bond goes down -bond price goes down, bond yield goes up

Private goods vs. public goods vs. common resources vs. club goods

-Private: goods that are both excludable and rival in consumption (ice cream cone) -Public: neither excludable nor rival in consumption (one person's use of a public good does not reduce another's ability to use it) -Common: goods that are rival in consumption but not excludable (fish in the sea) -club: excludable but not rival in consumption (fire protection)

market failure

-externalities are often discussed in the context of "market failure" -i.e. when the free market fails to generate the efficient allocation of resources -when consumer and producer surplus is not maximized

Key elements of a bond

-face value -maturity date -interest rate -coupon rate

Types of taxes

-income tax (federal and state) -property tax (local) -sales (state and local) and excise (federal and state) taxes and tariffs (federal)

Public goods have two special characteristics

-non-rival: your consumption does not diminish my consumption -non-exclusive: even if you don't pay for them, I can't exclude you from consuming

Positive externalities

-optimal quantity is found where the social-value curve and the supply curve intersect -socially optimal quantity is greater than the quantity that the private market would naturally reach on its own

Key economic role of the government

-people often free-ride on goods with positive externalities; thus these goods tend to be under produced by the free market, and governments typically step in to supply and subsidize them -many enhance economic output and so offset the deadweight loss from taxation

Positive externalities examples

-public education -public health and sanitation -transportation -national defense -criminal justice (national defense and criminal justice are called "public goods" too)

Suppose a firm faces a crisis of some type, what happens to the bondholders and the stockholders?

-the firm is bankrupt -stockholders are wiped out -bondholders will get something, though maybe not 100 cents on the dollar

3 main components of fiscal policy

1. Taxation 2. Government spending 3. Government borrowing (borrowing occurs to close the gap ("deficit") between spending and tax revenues

2 reasons for the Greek Crisis

1. contagion, i.e. fear of the PIIGS; and 2. Transaction costs, i.e. they don't want to go back to country-specific currencies

Free market conclusions

1. free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay 2. Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost 3. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus

When the government goes into the loanable funds market to borrow two things happen:

1. interest rate increases 2. total amount of private borrowing goes down, i.e. is "crowded out" of the market by the government borrowing

Raising funds in startup firms

1. max out "mom and dads" credit cards 2. maybe commercial bank 3. angel funds (smaller than venture capital, only difference is less 0's) 4. venture capital 5. going public via an IPO (initial public offering)

Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchase. (In fact, both the federal and state government impose the beer taxes of some sort). 1. Draw a supply and demand curve of market for beer without the tax. 2. Draw a supply and demand curve for beer with the tax

1. normal supply and demand curve (CS is above equilibrium, PS is below equilibrium 2. see picture

Types of government expenditures

1. transfers - SS, medicaid, medicare 2. goods with "positive externalities" and "public goods" - education, public health, transportation, national defense, criminal justice (items in #2 can enhance economic activity to offset the deadweight loss of the tax)

What is a government budget deficit? How does it affect interest rates, investment, and economic growth?

?

Suppose the congress and the president agree on a fiscal year deficit of $1 trillion. Ceteris paribus, to pay for this deficit, the U.s. Treasury would most likely ____, and the one result would be ___ pressure on interest rates. a. Purchase bonds from a large commercial bank, such as Bank of America; upward b. Borrow money from a large commercial bank, such as bank of America; downward c. Buy bonds; downward d. Sell bonds; upward

?

Suppose the demand for French bread rises. Explain what happens to producer surplus in the market for French bread. Explain what happens to producer surplus in the market for flour. Illustrate your answers with diagrams.

A rise in demand for french brea leads to an increase in producer surplus in the market for french bread. The shift in demand curve leads to an increased price, which increases producer surplus.

How does a tax on a good affect the price by paid by buyers, the price received by sellers, and the quantity sold?

A tax on a good raises the price buyers pay, lowers the price sellers receive, and reduces the quantity sold -Buyers and sellers "share the burden" - buyers pay a higher price for a smaller quantity and sellers receive a lower price for a smaller quantity

The demand curve for cookies is downward-sloping. When the price of cookies is $2, the quantity demanded is 100. If the price rises to $3, what happens to consumer surplus? a. falls by less than $100 b. falls by more than $100 c. rises by less than $100 d. rises by more than $100

A. falls by less than $100

Suppose the interest rate on a $1000 Bond is 6% per annum; and suppose the bond has two years to maturity; and suppose the discount rate is 7.5%. Calculate the bond price.

Bond price=[(.06x1000)/1.075]+[(.06x1000)/(1.075)2]+[1000/(1.075)2] =$973.06

John has been working as a tutor for $300 a semester. When the university raises the price it pays tutors to $400, Jasmine enters the market and begins tutoring as well. How much does producer surplus rise as a result of this price increase? a. by less than $100 b. between $100 and $200 c. between $200 and $300 d. by more than $300

B. between $100 and $200

Why does the discount rate sometimes increase, thus decreasing the price of a bond?

Because something (some economic variable) has changed. It's possible the default (or credit) risk of the issuer has increased, or the inflation risk has increased

Why doesn't the government simply end economic downturns and make us all richer via government spending and the multiplier?

Because the money has to come from somewhere, i.e. taxing, borrowing or printing, and there are negative impacts from each of these

If taxes create a deadweight loss and reduce output, then why doesn't the government just borrow (or even print) the money?

Because, like taxation, borrowing and printing money create their own economic problems. If you want the government programs, then it's going to cost you real economic resources

In what sense do positive externalities cause the so-called "invisible hand" of the marketplace to "fail"? a. Such externalities lead to government intervention in markets, which exacerbates the problems associated with externalities. b. Such externalities eliminate "free-riding" c. In the absence of government intervention, markets with positive externalities often fail to produce the maximum total benefit to society, as measured by total surplus d. Markets with positive externlaities produce to much of the good or service in question

C

Which of the following is an example of a positive externality? a. Dev mows Hillary's lawn and is paid $100 for performing the service. b. While mowing the lawn, Dev's lawnmower spews out smoke that Hillary's neighbor Kristen has to breathe. c. Hillary's newly cut lawn makes her neighborhood more attractive. d. Hillary's neighbors pay her if she promises to get her lawn cut on a regular basis.

C. Hillary's newly cut lawn makes her neighborhood more attractive

An efficient allocation of resources maximizes a. consumer surplus. b. producer surplus. c. consumer surplus plus producer surplus. d. consumer surplus minus producer surplus.

C. consumer surplus plus producer surplus

Many workers hold large amounts of stock issued by the firms at which they work. Why do you suppose companies encourage this behavior? Why might a person not want to hold stock in the company where he works?

Companies encourage their employees to hold stock in the company because it gives the employees incentive to care about the firm's profits, not just their own salaries. Then, if employees waste or see areas in which the firm can improve, they will take actions that benefit the company because they know the value of their stock will rise as a result. It also gives employees an additional incentive to work hard, knowing that if the firm does well, they will profit. But from an employee's POV, owning stock in the company for which she or he works can be risky. The employee's wages or salary is already tied to how well the firm performs. If the firm has trouble, the employee could be laid off or have her or his salary reduced. If the employee owns stock in the firm, then there is a double danger - the employee is unemployed or gets a lower salary and the value of the stock falls as well. Most employees would be better of diversifying - owning stock or bonds in other companies.

Elaine wants to buy and operate an ice-cream truck but doesn't have the financial resources to start the business. She borrows $10,000 from her friend George, to whom she promises an interest rate of 7 percent, and gets another $20,000 from her friend Jerry, to whom she promises a third of her profits. What best describes this situation? a. George is a stockholder, and Elaine is a bondholder. b. George is a stockholder, and Jerry is a bondholder. c. Jerry is a stockholder, and Elaine is a bondholder. d. Jerry is a stockholder, and George is a bondholder.

D. jerry is a stockholder, and George is a bondholder

What is diversification? Does a stockholder get a greater benefit from diversification when going from 1 to 10 stocks or when going from 100 to 120 stocks?

Diversification is the reduction of risk achieved by replacing a single risk with a large number of smaller unrelated risks. The stock holder would benefit more from diversification going from 1 to 10 because it would reduce the risk a lot more than going from 100 to 120 because they've already started with a lower risk.

Which kind of stock would you expect to pay the higher average return: stock in an industry that is very sensitive to economic conditions (such as an automaker) or stock in an industry that is relatively insensitive to economic conditions (such as a water company)? Why?

High returns are associated with high level of risk and lower risk fetch lesser returns. Thus, stock highly sensitive to economic conditions such as an automaker are likely to earn more returns on investment. On other hand, stock such as water company are insensitive to economic factor, hence likely to fetch lesser returns. If economy is facing adverse situation than momentarily such stock may earn decent returns.

If the government places a $500 tax on luxury cars, will the price paid by consumers rise by more than $500, less than $500, or exactly $500? Explain.

If the government imposes a $500 tax on luxury cars, the price paid by consumers will rise less than $500, in general. The burden of any tax is shared by both producers and consumers—the price paid by consumers rises and the price received by producers falls, with the difference between the two equal to the amount of the tax. The only exception would be if the supply curve were perfectly elastic, in which case consumers would bear the full burden of the tax and the price paid by consumers would rise by exactly $500.

Why is it important for people who own stocks and bonds to diversify their holdings? What type of financial institution makes diversification easier?

It is important because then they will have only a small stake in each asset, which reduces risk. Mutual funds make such diversification easy by allowing a small investor to purchase parts of hundreds of different stocks and bonds

What is efficiency? Is it the only goal of economic policymakers?

Maximizing the total surplus received by all members of society. Policymakers may also be concerned about equity and distribution of wealth

Suppose a ten year bond with $10,000 face value pays a 5% annual coupon (at the end of the year) has 2 years left to maturity, and has a discount rate of 6.5%. Which of the following would give you the present value - i.e. the price - of the bond?

PV = [500/1.065] + [500/1.065^2] +[10000/1.065^2]

For a closed economy, GDP is $12 trillion, consumption is $7 trillion, taxes net of transfers are $3 trillion and the government runs a deficit of $1 trillion. What are private saving and national saving?

Private saving = $2 National saving = $1

What exactly is meant by a fiscal "stimulus" i.e. what economic variable is being spurred?

Real GDP --> its a tapestry

Relatively inelastic supply and very elastic demand

Sellers are not very responsive to changes in the price (so the supply curve is steeper whereas buyers are very responsive (so the demand curve is flatter) -when the tax is imposed, the price paid by buyers does not rise by much, but the price received by sellers falls substantially. Thus, sellers bear most of the burden of the tax

Comparing stocks and government bonds, which type of asset has more risk? Which pays a higher average return?

Stocks have more risk because their value depends of the future of their firm, and because of the higher risk, shareholders demand a higher return.

Total surplus equation

TS = (value to buyers - amount paid by buyers) + )amount received by sellers - cost to sellers) OR TS= value to buyers - cost to sellers

Producer surplus

The difference between the minimum price a firm would accept (demand curve) and the price it actually receives -PS = amount received by sellers - cost to sellers

What is the role of the financial system? Name and describe two markets that are part of the financial system in the U.S. economy. Name and describe two financial intermediaries.

The financial system helps match one person's saving with another person's investment. Two markets: bond and stock market. Two financial intermediaries: banks and mutual funds. Banks take in deposits from people who want to save to make loans to people who don't want to borrow. Mutual funds sell shares to the public and use the proceeds to buy stocks and bonds

What factors should a stock analyst think about in determining the value of a share of stock?

The future probability of a firm

Keynesian Multiplier

The multiplier is the additional output generated by an increase in government spending - i.e. "fiscal stimulus"

Explain how sellers' costs, producer surplus, and the supply curve are related.

The seller cost is how much they pay to obtain a good. The PS is the amount they pay minus the cost of providing it. The supply curve measures this amount by looking at the area above the supply curve.

An early freeze in California sours the lemon crop. Explain what happens to consumer surplus in the market for lemons. Explain what happens to consumer surplus in the market for lemonade. Illustrate your answers with diagrams.

The supply curve for lemons shifts to the left. The result is a rise in the price of lemons and a decline in the consumer surplus.

Explain how buyers' willingness to pay, consumer surplus, and the demand curve are related.

They all measure the buyers willingness to pay for a good. The CS is just willingness minus the amount the buyer actually pays. The demand curve helps use measure this relationship by looking at the area below the demand curve and above the price is the sum of the consumer surplus

Externalities

Uncompensated benefits (or costs) granted by one party to (or inflected upon) another -there are positive and negative externalities

The interest rate is 7 percent. Use the concept of present value to compare $200 to be received in 10 years and $300 to be received in 20 years.

X/(1+r)^n 200/1.07^10 = $102 3001.07^20 = $78

Y = C + I + G + NX

Y = GDP C = consumption I = investment G = government purchases NX = net exports

Risk averse

a dislike of uncertainty -economists have developed models of risk aversion using the concept of utility, which is a person's subjective measure of well-being or satisfaction

Bonds (more important than stocks)

a financial security that represents a promise to repay a fixed amount of funds. It is a "debt instrument"

The balance sheet

a financial statement that sums up a firm's current financial situation -shows SE or "capital", which equals assets minus liabilities

A company faces two kinds of risk. A firm-specific risk is that a competitor might enter its market and take some of its customers. A market risk is that the economy might enter a recession, reducing sales. Which of these two risks would more likely cause the company's shareholders to demand a higher return? Why?

a firm-specific risk is more likely to cause the company's share holders to demand a higher return.

Adverse selection

a high-risk person is more likely to apply for insurance than a low-risk person

Hedge funds

a pool of funds created by a set of partners/owners for the purpose of investing in assets - typically riskier and more esoteric - that might not be available to other intermediaries -hedge funds do not take deposits, and their investment activities are not as regulated as those of commercial banks

Money market funds

a pool of funds created for the purpose of earning interest for shareholders while maintaining a net asset value (NAV) of $1 per share -a money market fund's portfolio is comprised of short-term (less than one year) securities representing high-quality (low risk), high-liquid debt instruments)

Mutual funds

a pool of funds created for the purpose of investing in a diversified set of securities, e.g. stocks or bonds or both (allows you to put your eggs in multiple baskets)

Budget deficit

a shortfall of tax revenue from government spending T - G < 0

Cost-benefit analysis:

a study that compares the cost and benefits to a society of providing a public good

Consider two bonds: X and Y. Ceteris paribus, we would expect the yield on bond X to be greater than the yield on bond Y if the two bonds have identical characteristics except that: a. Bond Y was issued by a corporation you consider to be financially strong; whereas Bond X was issued by a financially weak corporation b. Bond Y was issued by a country currently experiencing a financial crisis associated with a disastrous war; whereas Bond X was issued by the u.s. Treasury. c. Bond Y was issued by a corporation in a country currently experiencing inflation of 3 percent per annum; whereas bond X was issued by a country experiencing inflation of 1 percent per annum d. None of the above is correct. In each scenario bond x would be lower-yielding

a. Bond Y was issued by a corporation you consider to be financially strong; whereas bond X was issued by a financially weak corporation

Bond A pays $8,000 in 20 years. Bond B pays $8,000 in 40 years. (To keep things simple, assume these are zero-coupon bonds, which means the $8,000 is the only payment the bondholder receives.) a. If the interest rate is 3.5 percent, what is the value of each bond today? Which bond is worth more? Why? (Hint: You can use a calculator, but the rule of 70 should make the calculation easy.) b. If the interest rate increases to 7 percent, what is the value of each bond? Which bond has a larger percentage change in value? c. Based on the example above, complete the two blanks in this sentence: "The value of a bond [rises/falls] when the interest rate increases, and bonds with a longer time to maturity are [more/less] sensitive to changes in the interest rate."

a. PV bond A = 800/(1+.035)620 = $4020.53 PV bond B = 800/(1.035)^40 = $2020.58 b. PV bond A = 800/1.07^20 = 2067.35 % change PV bond A = (4020.53-2067.35)/4020.53 *100 = 48.58% PV bond B = 8000/1.07^40 = 534.24 % change PV bond B = (2020.58 - 534.24) / 2020.58 * 100 = 73.56% c. The value of a bond *falls* when the interest rate increases, and bonds with a longer time to maturity are *more* sensitive to changes in the interest rate

For each of the following pairs, which bond would you expect to pay a higher interest rate? Explain. a. A bond of the U.S. government or a bond of an Eastern European government b. A bond that repays the principal in year 2020 or a bond that repays the principal in year 2040 c. A bond from Coca-Cola or a bond from a software company you run in your garage d. A bond issued by the federal government or a bond issued by New York State

a. a bond of an easter European government b. A bond that repays the principal in year 2040 c. A bond from a software company you run in your garage d. A bond issued by the federal government

Suppose that Intel is considering building a new chip-making factory. a. Assuming that Intel needs to borrow money in the bond market, why would an increase in interest rates affect Intel's decision about whether to build the factory? b. If Intel has enough of its own funds to finance the new factory without borrowing, would an increase in interest rates still affect Intel's decision about whether to build the factory? Explain.

a. an increase in the interest rate discourages Intel to build a new chip making factory. Bonds are financial instruments through which a company can borrow from the public. When a company borrows fudns from public in the bond market, it has to give interest rate periodically. Paying interest rate is just like the cost of borrowing. When interest rates increases the cost of borrowing for the company increases. The reutnrs from the new factory may not be sufficient to cover the cost of borrowing and Intel is discouraged to build a new factory. b. Yes, an increase in interest rates will discourage the company to build a new chip factory even if the company decides to finance its project through its own resources. This is so because high interest rates make the bond market attractive for the company to invest in it. The expected returns from bond market will more than the expected returns from the newly build factory. So, high interest rates divert the company funds from building new factory to bond market.

Which of the following is the best example of a good or service that would be considered rival and excludable. a. clothes on your back b. US secret service c. NC state patrol d. Federal bureau of investigation

a. clothes on your back

Explain which category each of the following goods falls into: a. police protection b. snow plowing c. education d. rural roads e. city streets Why do you think the government provides items that are not public goods?

a. club good b. common good c. private good d. public good (everyone has equal access to roads) e. common When government provides a good, they charge a lower price as compared to private firms. Therefore, if private sector takes up the production for a project with higher cost, they tend to charge a higher price. Moreover private sector is less willing to take up a project if there are less return in future. As a result the government steps in and produce the good and provide it to public at cheaper rates.

Consider the market for fire extinguishers. a. Why might fire extinguishers exhibit positive externalities? b. Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value curve, the supply curve, and the social-cost curve. c. Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ. d. If the external benefit is $10 per extinguisher, describe a government policy that would yield the most efficient outcome.

a. fire extinguishers exhibit positive externalities because even though people buy them for their own use, they may prevent fire from damaging the property of others. b. see picture c. equilibrium output = first q line ; efficient output = second q line. These quantities differ because in deciding to buy extinguishers people don't account for the benefits they provide to other people d. Government policy should subsides $10 per fire extinguisher for efficient outcome

From 2008 to 2012, the ratio of government debt to GDP in the United States a. increased markedly. b. decreased markedly. c. was stable at a historically high level. d. was stable at a historically low level.

a. increased markedly

Which categories of goods are excludable? a. private goods and club goods b. private goods and common resources c. public goods and club goods d. public goods and common resources

a. private goods and club goods

Moral hazard

after people buy insurance, they have less incentive to be careful about their risky behavior because the insurance company will cover much of the resulting losses

Ceteris paribus, the primary advantage of investing in mutual funds over individual stocks or bonds is that mutual funds:

allow investors with relatively small amounts of money to diversify their investment porfolios

Internalizing the externality

altering incentives so that people take into account the external effects of their actions

Budget surplus

an excess of tax revenue over government spending T - G > 0

Sofia pays Sam $50 to mow her lawn every week. When the government levies a mowing tax of $10 on Sam, he raises his price to $60. Sofia continues to hire him at the higher price. What is the change in producer surplus, change in consumer surplus, and deadweight loss? a. $0, $0, $10 b. $0, −$10, $0 c. +$10, −$10, $10 d. +$10, −$10, $0

b. $0, -$10, $0

If the interest rate is 10 percent, then the present value of $100 to be paid in 2 years is a. $80 b. $83. c. $120. d. $121.

b. $83 PV = 100/(1+.1)^2

If the interest rate is zero, then $100 to be paid in 10 years has a present value that is a. less than $100. b. exactly $100. c. more than $100. d. indeterminate.

b. exactly $100

Which of the following is an example of a public good? a. residential housing b. national defense c. restaurant meals d. fish in the ocean

b. national defense

Which categories of goods are rival in consumption? a. private goods and club goods b. private goods and common resources c. public goods and club goods d. public goods and common resources

b. private goods and common resources

If a popular TV show on personal finance convinces Americans to save more for retirement, the ________ curve for loanable funds would shift, driving the equilibrium interest rate ________. a. supply, up b. supply, down c. demand, up d. demand, down

b. supply, down

Refer back to the previous question. Suppose you purchase this bond., but then, after you purchase it you discover the credit or default risk on the bond has increased. Ceteris paribus, it follows that the present value (i.e. the market value) would ____, and the yield would ____. a. Increase, decrease b. Increase, increases c. decrease , increase d. Decrease, decrease

c. decrease, increase

Suppose following the election of Donald Trump, the U.S. business community became more optimistic about the profitability of capital invested in U.S. industries. If follows that the ___ loanable funds would ___, putting ___ pressure on the equilibrium interest rate. a. supply of: decrease; upward b. supply of; decrease; downward c. demand for; increase; upward d. demand for; decrease; downward

c. demand for: increase; upward (supply side is savers, demand side is investors)

If the business community becomes more optimistic about the profitability of capital, the ________ curve for loanable funds would shift, driving the equilibrium interest rate ________. a. supply, up b. supply, down c. demand, up d. demand, down

c. demand, up

The benefit of diversification when constructing a portfolio is that it can eliminate a. speculative bubbles. b. risk aversion. c. firm-specific risk. d. market risk.

c. firm-specific risk

Because public goods are said to be ___, it follows that ____. a. excludable ; people have an incentive to be free riders b. Excludable; people do not have an incentive to be free riders c. Non-excludable; people have an incentive to be free riders d. Non-excludable; people do not have an incentive to be free riders

c. non-excludable; people have an incentive to be free riders

When an economist refers to "an efficient allocation of resources" she typically means ____ is maximized? a. CS, but not PS b. PS, but not CS c. sum of CS and PS d. CS - PS

c. sum of CS and PS

Which of the following is the best example of a good or service that would be considered non-rival and non-excludable? a. your breakfast b. congested interstate highway c. the US army d. Dr. Craig's corgi

c. the US army

Financial system

consists of the institutions that help to match one person's saving with another person's investment -financial markets and financial intermediaries

Goods with positive externalities tend to be ____ by the free-market private sector; thus in modern developed economies these goods are often ____. a. over-supplied; taxed b. under-supplied; taxed c. over-supplied; supplied or otherwise subsidized d. under-supplied; supplied or otherwise subsidized

d.

If the interest rate is 10 percent, then the future value in 2 years of $100 today is a. $80. b. $83. c. $120. d. $121.

d. $121 FV=(1+.1)^2 * 100

Suppose earlier this morning, your broker recommended you buy German government bonds for your personal investment portfolio. Ceteris paribus, it follows that the market is currently ___ German debt, and she expects German bond yields to ___ in the future. a. Over-pricing; increase b. Over-pricing; decreases c. Under-pricing; increase d. Under-pricing; decrease

d. under-pricing; decrease

Excludable vs. rival in consumption

excludable: the property of a good whereby a person can be prevented from using it rival: the property of a good whereby one person's use diminishes other people's use

Stock

financial security that represents partial ownership of a firm -the key feature of a stock is its dividend

Positive externality -->

free riding --> undersupply of this good --> government has to supply

If the government does something to increase its default/inflation risk, then, when it goes into the market to borrow (sell bonds) in the future interest payments will ______

go up because the discount rate goes up, and the price goes down, forcing up the yield (happened to Greece)

Open economy

interacts with other economies - NX doesn't = 0

Good company --> (more/less) risky --> bond demand (high/low) --> bond price (high/low) --> bond yield (high/low)

less; high; high; low

Junk bonds (high yield bonds)

low price, high yield -low price because high credit risk and low probability to get paid back

Bad company --> (more/less) risky --> bond demand (high/low) --> bond price (high/low) --> bond yield (high/low)

more; low; low; high

Free riding

occurs when the beneficiaries of goods and positive externalities do not pay for those goods -one of the key economic roles of government is to eliminate or reduce free-riding -this is why goods with positive externalities are typically supplied or subsidized by the government

Crowding out

occurs when the government run budget deficits, i.e. when they borrow through the bond market -government borrowing reduces the supply of private savings and investment; and thus increases interest rates (loanable fund model)

Dividend

profit earned by a corporation and distributed to its shareholders

Market risk

risk that affects all companies in the stock market

firm-specific risk

risk that affects only a single company

Debt finance

sale of bonds to raise money

Equity finance

sale of stock to raise money

Elastic supply and relatively inelastic demand

sellers are very responsive to changes in the price of the good (so the supply curve is relatively steep) -the price paid by buyers rises substantially, indicating that buyers bear most of the burden of the tax

Compounding

the accumulation of a sum of money in, say, a bank account, where the interest earned remains in the account to ear additional interest in the future X/(1+r)^n

Future value

the amount of money in the future that an amount of money today will yield, given prevailing interest rates

Present value

the amount of money today that would be needed, using prevailing interest rates, to produce a given future amount of money

If the discount rate increases....

the bond price decreases

Efficient market hypothesis

the current market value of an asset reflects all publicly available information about that asset, and therefore, one cannot systematically "beat the market" -this means the price of an asset is equal to its "fundamental" value plus a random component --> Ps=Pf+E (E is the random component that cannot be systematically predicted by mere mortals)

Maturity date of a bond

the date at which the bond "matures" or is paid off

Consumer surplus

the difference between a consumer's willingness to pay (demand curve) and the price the consumer actually pays -measure of consumer welfare/wellbeing -CS = Value to buyers - amount paid by buyers

Private saving

the income that households have left after paying for taxes and consumption Y - T - C

Tax Incidence

the manner in which the burden of a tax is shared among participants in a market

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 -loanable funds: refers to 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

Willingness to pay

the maximum amount that a buyer will pay for a good

Face value of a bond

the nominal value of a bond, as declared by its issuer

Interest rate of a bond

the periodic cost of borrowing funds, usually expressed as a percentage of the amount borrowed

Coupon payment

the periodic interest payment on a bond -thus, the coupon payment is the interest rate times the "face" or "par" value of the bond

Financial intermediation

the process of bringing together the parties involved in a financial transaction -ex. commercial bank: brings borrowers and lenders together through "maturation intermediation" -other intermediaries include: investment banks, mutual funds, money market funds, and hedge funds

Efficiency

the property of a resource allocation of maximizing the total surplus received by all members of society

Equality

the property of distributing economic prosperity uniformly among the members of society

Diversification

the reduction of risk achieved by replacing a single risk with a large number of smaller, unrelated risks -reduces risk of holding stocks, but it does not eliminate it -mutual funds

Deadweight loss

the surplus lost as a result of a market distortion, such as a tax -ex.) people to collect money, enforce tax laws, and spend the money -means that you can't take taxes and fully "give money back" to consumers by spending it

Public saving

the tax revenue that the government has left after paying for its spending T - G

National saving

the total income in the economy that remains after paying for consumption and government purchases Y - C - G = I S = I S = Y - C - G T = Taxes minus transfer payments *S = (Y - T - C) + (T - G)*

Opportunity cost

the value of everything a seller must give up to produce a good