Chapter 10: Savings, Investment Spending, and the Financial System

5%

Use Table: Loanable Funds. At what interest rate will the market for loanable funds be in equilibrium?

$1.6 trillion.

Use Table: National Income Accounts. The value of national savings is:

housing

A bubble in _____ between 2000 and 2006 contributed to the 2008-2009 recession in the United States.

rate of return on the project is at least as high as the interest rate on the loan.

A business will be likely to borrow to fund projects if the:

investment spending.

The money spent to purchase physical capital that adds to the economy's stock of physical capital is called:

$246.81.

The present value of $300 received in four years if the annual interest rate is 5% is:

nominal interest rate minus the inflation rate.

The real interest rate is the:

supply for loanable funds shifts to the right.

On a graph, if households and firms increase the level of private savings because they become pessimistic about the future, then the:

b) JR believes that he may be laid off from his job within the next 6 months.

Which of the following situations would likely lead to a higher savings rate in the short run?

QUIZ Q'S //////////////////////////////////////////// adding to physical capital.

Investment spending in macroeconomics refers to:

decrease transaction costs.

One reason financial institutions become very large is to:

downward because quantity demanded is lower when the price to borrow money is higher.

The demand curve for loanable funds slopes:

4%; $5 billion

The figure shows a loanable funds market. The equilibrium interest rate is _____ and the equilibrium quantity of loanable funds is _____.

real interest

The true cost of borrowing is the _____ rate.

Capsland's budget balance = % Marsalia's budget balance = % Capsland is running a budget Marsalia is running a budget

What is the budget balance (as a percentage of GDP) in both countries? Are Capsland and Marsalia running budget deficits or surpluses?

Capsland's budget balance = 5 % - running a budget surplus Marsalia's budget balance = -3 % - running a budget deficit

What is the budget balance(as a % of GDP) in both countries? Are Capsland and Marsalia running a budget deficits o surpluses? CAP: I 20% , PS 10% , NCI 5% MAR: I 20% , PS 25% , NCI -2%

a financial institution that transforms investor funds into financial assets

Which of the following best defines a financial intermediary?

a.) investment: $ 50 million What is national saving in this economy? saving: $ 50 million b.) National saving equals investment.

In a small, closed economy, national income (GDP) is $500.00 million for the current month. Individuals have spent $300.00 million on the consumption of goods and services. They have paid a total of $200.00 million in taxes, and the government has spent $150.00 million on goods and services this month. Use this information and the national income identity to answer the questions. a.) How much is spent on investment in this economy? b.) How are investment and national saving related in an economy like this?

12.5%

Mama's Pies, a baking company, adds another store to sell its pastries. The new store costs $400,000 to build and it will generate revenues of $450,000. The rate of return on this investment is _____%.

$550,000.

Papa's Tamales adds another store to sell its pastries. The new store costs $500,000 to build and the new store is projected to generate a rate of return on investment of 10%. The projected revenues from this new store are:

household income minus taxes minus consumption.

Private savings equals:

bank

A _____ is a financial intermediary that provides liquid assets in the form of bank deposits to lenders and uses those funds to finance the illiquid investment spending needs of borrowers.

financial asset

A(n) _____ is a paper claim that entitles the buyer to future income from the seller.

Julius John Osi Jolien

After reading the given descriptions, please place the correct label by the quadrant on the graph that best describes each person's position in the market for loanable funds. ~ Jolien decides not to take out a loan to fund expanding her grocery store because she projects it will only earn a return of 4% . ~ Osi closely follows the market for United States Treasury Bonds. He is willing to invest in them anytime the rate of return is 5% or higher, and sees that this is the case. ~ In order to open a new car wash facility expected to return 13% , Julius secures a loan. ~ John will shift his stock investments to corporate bonds when they return at least 10% . They do not, so he stays with stocks

present value.

An amount that would equal a particular future value if deposited today at the prevailing interest rate is the:

are standardized and therefore are easier to sell than loans.

An important advantage of bonds as a financial asset is that they:

$3,471.

An investment project costs $3,000 now and will return $2,000 at the end of each of the next two years. If the annual interest rate is 10%, the present value of the benefits is:

Private savings = $ million

Assume a hypothetical economy that is open to capital inflows and outflows, so that net capital inflow equals imports (IM) minus exports (X). a. The economy has the following properties: X = $125 million IM = $80 million Budget balance = −$200 million I = $350 million Calculate private savings in millions of dollars.

Private savings = $ million

Assume a hypothetical economy that is open to capital inflows and outflows, so that net capital inflow equals imports (IM) minus exports (X). a.) The economy has the following properties: X = $125 million IM = $80 million Budget balance = −$200 million I = $350 million Calculate private savings in millions of dollars.

a.) Shift Demand left b.) increased because the cost of borrowing decreased.

Collaboration with Congress during the Clinton Administration allowed for an aggressive deficit-cutting plan to pass. As a result, the government was able to reach a balanced budget at the end of the 90's. a.) Move the supply and/or demand curves to describe the expected effect that this deficit-reduction likely had upon the loanable funds market. b.) As a result, private investment should have

1.) True 2.) False 3.) True 4.) False 5.) False 6.) False

Determine if the following statements are true or false. 1.) An increase in government spending can crowd out private investment. 2.) An improvement in the budget balance increases the demand for financial capital. 3.) An increase in private consumption may crowd out private investment. 4.) Lower interest rates can lead to private investment being crowded out. 5.) A trade balance in surplus increases the supply of financial capital. 6.) If private savings is equal to private investment, then there is neither a budget surplus nor a budget deficit.

not develop the denture.

Doug's Dentistry is developing a new denture which will cost $10 million to develop. Doug expects a rate of return of 25%. If the interest rate is 26%, Doug should:

a.) Shift demand to right b.) The deficit increases the demand for loanable funds and shifts the demand curve to the right; increasing the interest rate and crowding out investment spending.

a.) Adjust the graph to show how a $25.8 billion dollar increase in the government's budget deficit affects the hypothetical loanable funds market below, holding all else equal. b.) Select the answer that describes the adjustment in the loanable funds market.

END OF CHAPTER////////////////////////////////// I = $ 280 million Private Savings = $ 220 million Budget balance = $ 60 million National Savings = $ 280 million

Given the following information about the closed economy of Brittania, what is the level of investment spending and private savings, and what is the budget balance? Assume there are no government transfers. GDP𝐶=$1430.00 million=$850.00 million𝑇=$360.00 million𝐺=$300.00 million

Demand shifts ; left Supply shifts ; right Equilibrium shifts : down

Using the accompanying diagram, illustrate what will happen to the market for loanable funds when there is a fall of 2 percentage points in the expected future inflation rate.

END OF CHAPTER Q'S/////////////////////////////// I = $ million Private Savings = $ million Budget balance = $ million National Savings = $ million

Given the following information about the closed economy of Brittania, what is the level of investment spending and private savings, and what is the budget balance? Assume there are no government transfers. GDP𝐶=$1430.00 million=$850.00 million𝑇=$360.00 million𝐺=$300.00 million

A : Increase B : Increase C : Stays the same D : Stays the same

Identify the effect on a company's stock price today of each of the following events, other things held constant. a.) The interest rate on bonds falls. The company's stock price (A). b.) Several companies in the same sector announce surprisingly higher sales. The company's stock price (B). c.) A change in the tax law passed last year reduces this year's profit. The company's stock price (C) . d.) The company unexpectedly announces that due to an accounting error, it must amend last year's accounting statement and reduce last year's reported profit by $5 million. It also announces that this change has no implications for future profits. The company's stock price (D).

net capital outflow.

If a country has a trade surplus, we can conclude that it also has a:

decrease.

If investors expect a stock will be less valuable in the future, they will demand less of it and the price will MOST likely:

additional demand for

If the government increases its borrowing, then at every interest rate there is a(n) _____ funds.

Positive

If the interest rate is _____, the future value is always larger than the present value.

a) Interest rates will fall to spur greater investment.

If the level of saving in an economy exceeds investment, what will likely happen to interest rates as the economy moves toward equilibrium?

3

In the underground city of Neverwhere, GDP is $15 trillion, consumption is $10 trillion, and government spending is $2.5 trillion. Taxes are $1 trillion and the net capital inflow is $0.5 trillion. Total savings for the economy of Neverwhere is $_____ trillion.

Investment Spending - Ronald Basketballstar - Rawlings Investing in Financial Assets - Rupert Moneybuckets - Russia Investing in Physical Assets - Rhonda Moviestar

Indicate whether each of the following is an example of investment spending, investing in financial assets, or investing in physical assets. ~ Rupert Moneybucks buys 100 shares of existing Coca-Cola stock. ~ Rhonda Moviestar spends $10 million to buy a mansion built in the 1970s. ~ Ronald Basketballstar spends $10 million to build a new mansion with a view of the Pacific Ocean. ~ Rawlings builds a new plant to make catcher's mitts. ~ Russia buys $100 million in U.S. government bonds.

liability to Mary and an asset

Mary receives a loan from a bank. The loan is a(n) _____ to the bank.

the budget balance.

National savings is the sum of private savings and:

in the latter, foreign savings complement domestic savings in financing investment spending.

One difference between a closed and an open economy is that:

a.) Quantity supplied will increase. b.) Quantity demanded will increase. c.) interest rate d.) The business will not take out the loan.

Please answer the given four questions related to the market for loanable funds. a.) What effect will an increase in interest rates have on the quantity of loanable funds supplied? b.) As interest rate decreases, what happens to the quantity of loanable funds demanded? c.) Which of the terms acts as the "price" in the market for loanable funds? d.) If the projected rate of return for a project is less than the interest rate for a loan that is necessary to complete the project, how will the borrowing business act?

~ Shift in Supply ~ Shift in Demand ~ Shift in Demand ~ Shift in Supply

Please decide whether each of the scenarios related to the loanable funds market will result in a shift in supply or a shift in demand. China decides to reduce its capital investment in the United States, as it expects low returns due to a weak U.S. economy. Calopolis, a college town in Northern California, has for many years banned the presence of fast food restaurants in city limits. As of 2012, however, the city will allow several fast food companies to open franchised locations. Due to an increase in revenues after a tax hike, the United States is able to eliminate the deficit and begins to maintain a balanced budget for the first time in several decades. As a result of a stock market boom, individuals begin to feel richer and spend more while also saving less.

a.) Wayne projects that if he takes out a loan to open another gym franchise, he will earn a lower return than the interest rate he would have to pay, so he decides against it. b.) 10% c.) $50 billion

Please use the graph to answer the given questions. Assume the people act rationally. a.) Which of the statements best describes a situation represented by point A? b.) Given the market conditions, what will be the prevailing interest rate? c.) Given the market conditions, how much will be available in loanable funds?

a.) Bond b.) Stock c.) Bank Deposit d.) Loan

Select the proper term for each definition. a.) A promise to pay issued by a borrower with annual interest payments and a principal payment at maturity. b.) a share of ownership in a company c.) funds that are kept in a bank that must be relinquished upon the owner's request d.) an agreement between a lender and a borrower

liability; financial asset

Suppose that Jim just got a $20,000 loan from his credit union to buy a new car. The loan is a _____ for Jim and a _____ for the credit union.

budget deficit

The _____ is the difference between tax revenue and government spending when tax revenue is less than government spending.

a.) Shift Supply Left Shift Demand Right b.) 3% c.) The Fisher effect

The accompanying graph represents the market for loanable funds in the hypothetical country of Bunko. Assume the market is initially in equilibrium and inflation expectations are 2%. a.) Adjust the graph to demonstrate the effects of inflation expectations increasing from 2% to 4%. b.) What is the real interest rate after the change in inflation expectations? c.) Which effect below characterizes the relationship between inflation expectations and nominal interest rates?

it can be tailored to the needs of the individual borrower.

The advantage of a loan is that:

land labor money machinery human capital

Which is NOT an example of a resource?

c) A stockholder receives the amount it invests plus interest at a fixed time in the future.

Which of the following is not true about the stock market?

Stocks are usually more risky than bonds.

Which statement is true concerning the relative risk of stocks and bonds?

a.) True : ~ The national savings are the combined value of all private savings and the budget balance. ~ The budget balance can be either positive or negative. False : ~ Outflows of funds only be generated by countries with a larger GDP per capita than the country receiving the funds. ~ National budget deficit are not included in the calculation of national savings. b.) National savings are repaid domestically, whereas capital inflows are repaid to a foreigner.

a.) Determine whether the statements listed regarding the savings-investment spending identity are true or false. b.) How does funding from national savings differ from funding obtained from capital inflows?

a.) D b.) Consumers consider future inflation.

a.) Which of the four graphs best demonstrates the Fisher effect? b.) Which of these statements best summarizes the impact of the Fisher effect?

financial intermediary

A _____ transforms the funds it gathers from many individuals into financial assets.

1 : Securitization 2 : Diversification 3 : Liquidity 4 : More 5 : More 6 : Lower 7 : Losses 8 : Riskier 9: Less 10 : Higher

Sallie Mae is a quasi-governmental agency that packages individual student loans into pools of loans and sells shares of these pools to investors as Sallie Mae bonds. a.) Sallie Mae's packaging process is called (1). Compared to a scenario where investors can only buy and sell individual loans, the pooling process results in (2) and (3) for an investor. b. Sallie Mae's actions will cause investors to supply (4) funds to students, creating (5) loans at a (6) interest rate. c. Suppose that a very severe recession hits and, as a consequence, many graduates cannot get jobs and default on their student loans. These defaults will create (7) for investors and cause the bonds to become (8) than expected, leading to (9) loans available at a (10) interest rate.

PRE-TUTORIAL////////////////////////////////////// b) supply of loanable funds would increase and interest rates would fall

Suppose the government introduces a new incentive for individuals to save money for retirement. How would this affect the market for loanable funds and the interest rate?

expected real rate of interest is unaffected by the change in expected inflation.

The Fisher effect states that the:

LEARNING CURVE////////////////////////////////// present value of current and future benefits of a project minus the present value of current and future costs.

The net present value of a project is the:

As a result of the increase in education spending, the equilibrium interest rate (A) by (B) percentage points, and the equilibrium quantity of loanable funds (C) by (D) billion dollars. This (E) an example of crowding out. A : Increase B : 2 C : Increase D : 100 E : is

The government is running a budget balance of zero when it decides to increase education spending by $200 billion and finance the spending by selling bonds. The accompanying diagram shows the market for loanable funds before the government sells the bonds. Assume that there are no capital inflows or outflows.

$100.

The present value of a $110 payment in one year, given an annual 10% interest rate, is:

the interest rate is higher rather than lower.

The present value of a future payment is smaller when:

Investment projects that are financed by savers have larger rates of return than projects that do not receive financing. Savers who lend money are willing to accept a lower minimum interest rate than potential savers who do not lend money.

There are two aspects of efficiency that the equilibrium of market for loanable funds exhibits. Select the TWO statements that characterize these two aspects of efficiency.

a smaller

Use Figure: The Market for Loanable Funds II. Other things being equal, if there is an increase in the interest rate above 8%, _____ quantity of loanable funds will be demanded.

$200.

Use Table: Investment Projects. If the market interest rate declines from 15% to 13%, then the amount of investment demanded will increase by:

10%

Use Table: Investment Spending, Private Spending, and Capital Inflows. What is the budget balance as a percentage of GDP in Northlandia?

HOMEWORK Q'S//////////////////////////////////// a.) ~ Budget Balance ~ National Savings ~ Budget Deficit ~ Capital Inflow ~ Budget Surplus b.) investment spending and savings are always equal.

a.) Please match each term with the correct definition. ~The difference between the amount the government collects and how much it spends is known as the_____. ~When the preceding term is combined with all of the privately held savings from across the country, it is known as the_____. ~ If the government spends more money than it takes in through taxes, it will experience a____. ~ The net amount of funds coming into a country is the____. ~ If the government spends less money than it takes in through taxes, it will experience a_____. b.) The fundamental relationship between savings and investment spending is thato

a.) Bonds b.) Loans c.) Stocks d.) Loan- Backed Securities e.) Loans

Determine which financial asset is described in each scenario. a.) Caleb has completed a prototype garlic-peeling device that he hopes to sell to the public. b.) Audrey wants to buy a new car but does not have enough cash. c.) Lyle and Shane start a business selling pencil sharpeners to elementary schools. d.) Rand Capital Corporation, a financial industry conglomerate, pools together several hundred home mortgages and sells shares in them to groups of investors. e.) Jack decides to build a chateau in the mountains of Colorado and operate it as a ski resort.

WORK IT OUT/////////////////////////////////////// A : decrease B : demand C : fall D : increase E : supply F : fall G : demand H : increase I : rise

If the government reduces the size of its deficit to zero, there will be (A) in the (B) of loanable funds. Reducing deficits to zero will cause interest rates to (C). At any given interest rate, if consumers decide to save more, and the government budget remains unchanged, there will be (D) in the (E) of loanable funds. This will cause the interest rate to (F). At any given interest rate, if businesses become very optimistic about the future profitability of investment spending, and the government budget remains unchanged, then the (G) will (H). This will cause interest rates to (I).

"making an investment."

Purchasing an asset such as a share of stock, a bond, or existing real estate is:

bank deposits.

The financial assets with the least risk are usually: