Ch. 29 (Saving, Investment, and the Financial System)

What is the role of the financial system?

The financial system is meant to bridge the gap between lenders/savers and borrowers

How does government borrowing affect the demand for loanable funds? How does government borrowing affect the supply of loanable funds?

The government borrowing drastically increases the demand for loanable funds when they invest because they are so large. They affect the supply is affected when the government issues bonds.

Why is the supply of loanable funds upward sloping?

The higher the interest rate (price) the more incentive people have for saving money, so people will supply more with a higher rate

Why is the demand for loanable funds downward sloping?

The higher the interest rates, the less people will want to borrow money

Why do people use banks to funnel their savings to borrowers instead of performing this function themselves?

The people don't have to worry about deciding whether the loan is a good idea or not, the bank does the due diligence and coordinates the deposits.

How do banks play the role of a financial intermediary?

They give savers a way to help loan money to large borrowers without having to worry about the loan or the risk

What is the difference between a T-bond, T-note, and T-bill?

Treasury bills have maturities of a year or less. Treasury notes are issued with maturities from two to ten years. Treasury bonds are long-term investments that have maturities of 10 to 30 years from their issue date.

How do you compare the value of two different sums of money over time?

You can either convert a present value to a FV and compare them, or convert a FV to a PV and compare them

What is a financial intermediary?

A financial intermediary is an institution that connects savers/lenders to borrowers

What is the difference between an initial public offering (IPO) and a secondary stock?

An IPO is when stocks are sold directly from the company. This is when the founders and VC invest their money. Secondary stocks are bought from people other than the company. There are no new secondary stocks, they are all just transferences of ownership

Who buys a bond?

Anyone can buy a bond, even the government

What is the function of a bank?

Banks compile money from thousands of small lenders and coordinate their money into larger effective loans while also keeping enough reserves for depositors to withdrawal

Who demands loanable funds?

Borrowers like students, businesses, entrepreneurs

What is crowding out?

Crowding out is when the government's investment interferes with private borrowing and private saving/consumption

What impact does government borrowing have on the equilibrium interest rate?

Government borrowing drastically hikes up the interest rates because it shifts the demand curve up and right

How does a change in the demand for loanable funds affect the quantity of savings/borrowing and the equilibrium interest rate?

If the government vowed to give a 15% tax break on people enrolled in college, there would be a massive increase in college enrollment and student loans. This would shift the demand curve up and right. At the current interest rate, there will be a shortage of loanable funds. The equilibrium interest rate will decrease and the equilibrium quantity of loanable funds will increase.

How does a change in the supply of loanable funds affect the quantity of savings/borrowing and the equilibrium interest rate?

If, for some reason, a lot of people decided that putting money into savings accounts was the best investment, the supply curve will shift right and down. If the banks were to keep the same interest rates, there would be a surplus. The equilibrium interest rate will decrease and the equilibrium quantity of loanable funds will go up.

How do insecure property rights affect the quantity of savings and investment within an economy and affect long run economic growth?

Insecure property rights scare away saving, and this causes intermediation to fail

Why do people save money?

People save money so they can have more funds when their consumption exceeds their income

What is the difference between a stock and a bond?

A bond is an IOU that is guaranteed plus interest by a certain date. Bonds do not grant ownership in a company.

What is a zero-coupon bond?

A bond that is issued at a deep discount to its face value but pays no interest

What is a stock exchange?

A stock exchange is a market in which shares of stock can be bought or sold and transfer ownership.

What is a stock? Why do firms sell stocks?

A stock is partial ownership in a corporation. Firms sell stock to raise capital.

How does politicized lending and government owned banks affect the quantity of savings and investment within an economy and affect long run economic growth?

§ Government involvement in banks tends to leading money for politically connected reasons § Instead of just lending money to the best candidates, banks lend money to firms with political connections

What is future value (FV)? What information do you need to calculate the FV of an asset?

§ The value that a sum of money today will be worth at some point in the future if invested for a return § You need present value, interest rate, and number of periods

What is present value (PV)? What information do you need to calculate the PV of an asset?

§ Today's value of a future cash flow § Future cash flow amount, number of periods until cash flow will be received, the discount rate

How do bank failures and panics affect the quantity of savings and investment within an economy and affect long run economic growth?

§ If depositors lose trust in their bank's ability to give back their money, they'll rush to the bank to withdraw their money, causing it to go bankrupt if enough depositors do it at once § If investors believe that bank managers are just trying to rip them off rather than to promote long term capital growth, this will scare off investors

How do controls on interest rates (usury laws) affect the quantity of savings and investment within an economy and affect long run economic growth?

§ Usury laws cause interest rates to be below equilibrium interest rates, which makes more borrows wanting to borrow than lenders willing to lend § This creates a shortage and a drop in the overall quantity of lending

Who supplies loanable funds?

Depositors, or people who save their money in a bank

Who issues (i.e. sells) bonds?

Companies,governments, or banks issue bonds

What impact does government borrowing have on savings? Consumption? And investment?

Government borrowing turns savings into investment, and decreases consumption

Why do people borrow money?

People borrow money to fill the gap between their income and consumption, when they are consuming more than they are earning, like the college ages

What is the price of saving and borrowing? How does a change in this price affect the quantity borrowed and the quantity saved?

The price of saving and borrowing is the interest rate. High interest rates incentivize people to save/lend more and borrow less. Low interest rates incentivize people to borrow more and save/lend less

If the interest rate increases, does the demand for loanable funds change? Does the quantity demanded of loanable funds change?

The quantity of loanable funds demanded will decrease because will people will have to pay more to borrow money, giving less incentives. The demand does not change because it is just a price change not a shift.

If the interest rate increases, does the supply of loanable funds change? Does the quantity supplied of loanable funds change? For each question, explain why or why not.

The quantity of loanable funds supplied will increase, people will want to supply more loanable funds because they have more of an incentive. The supply does not change because this is simply just a price change, not a shift.