Chapter 13: Savings, Investment, and the Financial System

Which of the following situations represent investment and which represent saving? Explain. Your roommate earns $100 and deposits it in his account at a bank.

it is saving as the roommate is not using his income to purchase consumer goods

What are two policies to increase private saving?

1. Move from an income tax to a consumer tax (VAT) -not equitable for the poor; disproportionate 2. Raise incentives to save by expanding tax-deferred saving accounts -IRS and 401(k)s

What are examples of financial institutions?

Banks, mutual funds, hedge funds, insurance companies

Which of the following situations represent investment and which represent saving? Explain. You borrow $1,000 from a bank to buy a car to use in your pizza delivery business.

It is investment as you are using income to purchase a capital good for a business

Which of the following situations represent investment and which represent saving? Explain. You use your $200 paycheck to buy stock in AT&T.

It is saving as you are not using your income to purchase consumer goods

How can you shift the Supply of Loanable Funds curve to the left?

Decrease National Saving: 1. Consumption increases 2. Government spending increases 3. Net Taxes decreases

What is the investment tax credit?

Firms may deduct a fraction of investment from its tax bill;

How can you shift the Demand of Loanable Funds curve to the right?

Increase in Investments: 1. Consumers and Businesses are more confident 2. Increase in expected future profits 3. Decrease in expected future business taxes 4. Tax incentives to encourage investment

Suppose the government borrows $20 billion more next year than this year. Use a supply-and-demand diagram to analyze this policy. Does the interest rate rise or fall?

Increased government borrowing will DECREASE the Supply of Loanable Funds, meaning the curve will shift to the left. The supply curve shifting to the left will increase the interest rate

What does a consumption tax do?

Increases private savings as consumer products will increase in price and consumers will have an incentive to save

What happens to investment if the interest rate increases?

It decreases

Which of the following situations represent investment and which represent saving? Explain. Your family takes out a mortgage and buys a new house.

It is an investment as it is a purchase of new capital

What happens in a closed economy?

NX = 0

What is the equation for taxes?

Net Taxes = Taxes - Transfers

What are the two types of savings?

Private saving done by households and government saving (or public) saving (Sp + Sg)

In a closed economy, if Y remained the same, but G rose, T rose by the same amount as G, and C fell but by less than the increase in T, what would happen to private and national saving? a. national saving would fall and private saving would rise b. national saving would rise and private saving would fall c. both national saving and private saving would fall d. None of the above is correct.

Recall: Sp = Y - C - T Sg = T - G So, Sp = (Y) - C(v) - T(^) Sg = T(^) - G(^) Sp falls and Sg remains the same. So, S will fall as well. c. both national saving and private saving would fall.

For an imaginary closed economy, T = $5,000; S = $11,000; C = $48,000; and the government is running a budget surplus of $1,000. Then a. private saving = $10,000 and GDP = $55,000. b. private saving = $10,000 and GDP = $63,000. c. private saving = $12,000 and GDP = $67,000. d. private saving = $12,000 and GDP = $69,000.

S = Y - C - G $11,000 = Y - $48,000 - ($5,000 + $1,000) $11,000 = Y - $48,000 - $4,000 $11,000 = Y - $52,000 Y = $63,000 b. private saving = $10,000 and GDP = $63,000

When you buy corporate or government bonds, are you investing or saving?

Saving

When you deposit in a saving account, are you investing or saving?

Saving

What is the Supply of Loanable Funds equal to?

Savings = Sp + Sg

What is the equation for Sg?

Sg = T - G

What are transfers?

Social Security, Welfare, etc.

What is the equation for national savings?

Sp + Sg = (Y - T - C) + (T - G) = Y - C - G

Economists in Funlandia, a closed economy, have collected the following information about the economy for a particular year: Y = 10,000 C = 6,000 T = 1,500 G = 1,700 The economists also estimate that the investment function is: I = 3,300 - 100r where r is the country's real interest rate, expressed as a percentage. Calculate private saving, public saving, national saving, investment, and the equilibrium real interest rate.

Sp = Y - C - T So, Sp = 10,000 - 6,000 - 1,500 Sp = 2,500 Sg = 1,500 - 1,700 Sg = -200 National Savings = Sp + Sg National Savings = 2,300 Investment = 2,300 2,300 = 3,300 - 100r -1,000 = -100r r = 10%

What is the equation for Sp?

Sp = Y - T - C

What are examples of financial markets?

Stock Market, Bond Market, The "Money" Market, Foreign Exchange Market

Suppose the government borrows $20 billion more next year than this year. What happens to investment? To private saving? To public saving? To national saving? Compare the size of the changes to the $20 billion of extra government borrowing.

The supply curve will shift to the left Investment will decrease as the interest rates rose Private saving will increase as the interest rates rose National Saving will decrease as the interest rates rose Investment and National Savings will decrease by less than $20 billion. Public Saving will decrease by $20 billion Private Saving will increase by less than $20 billion

When a government borrows to finance budget defecit, what happens to the interest rates? Consumption? Investment? Private Savings?

They increase while consumption and investment both decrease as private savings increase

How does the government borrow?

Through bonds

Explain the difference between saving and investment as defined by a macroeconomist.

To a macroeconomist, saving occurs when a person's income exceeds his consumption, while investment occurs when a person or firm purchases new capital, such as a house or business equipment.

What are the effects of tax cuts?

Usually consumption increases, thus decreasing savings which means the supply of loanable funds curve will shift to the left.

Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving is $0.5 trillion, and public saving is $0.2 trillion. Assuming this economy is closed, calculate consumption, government purchases, national saving, and investment.

Y = $8 trillion Net Taxes = $1.5 trillion Sp = $0.5 trillion Sg = $0.2 trillion Recall: Sp = Y - C - T So, $0.5 = $8 - C - $1.5 C = $8 - $1.5 - $0.5 C = $6 trillion Recall: National Savings = Y - C - G So, $0.7 = $8 - $6 - G G = $8 - $6 - $0.7 G = $1.3 trillion Recall: Savings = Investment So, I = $0.7 trillion

What is normal GDP in a closed economy?

Yn = C + I + G

What are financial institutions?

intermediaries indirectly match the saving of one person to the investment of others; banks

In 2002 mortgage rates fell and mortgage lending increased. Which of the following could explain both of these changes? a. The demand for loanable funds shifted rightward. b. The demand for loanable funds shifted leftward. c. The supply of loanable funds shifted rightward. d. The supply of loanable funds shifted leftward.

c. The supply of loanable funds shifted rightward

What is monetary policy?

changes money supply and interest rates

The global economy is a closed economy (since we do not trade with Martians, yet). In recent years the rise of China and other countries in Asia with high savings rates has dramatically increased global saving. Meanwhile the economic downturn has slowed business desire to investment in plant and equipment. In addition, across the globe government's have reduced government budget deficits (often called a fiscal consolidation). Finally, global inflation has fallen in recent years. Together these events imply that in recent years: a. real interest rates are falling, nominal interest rates are rising, and the level of global investment is stable. b. real interest rates and nominal interest rates are rising, and the level of global investment is falling. c. real interest rates and nominal interest rates are falling, and the level of global investment is stable. d. real interest rates and nominal interest rates are falling, and the level of global investment is uncertain.

d. real interest rates and nominal interest rates are falling, and the level of global investment is uncertain. An increase in global saving = shift to the right for the Supply Curve Slowed business desire to invest = shift to the left for the Supply Curve Reduced Government Budget Deficits = shift to the right for the Supply Curve Global Inflation falling = real interest rates and nominal interest rates are falling Because there is so much uncertainty regarding the shift of investment, d is the only feasible answer.

Suppose the market for loanable funds is in equilibrium. What would happen in the market for loanable funds, other things the same, if the Congress and President increased the maximum contribution limits to 401(k) and 403(b) tax- deferred retirement accounts? a. the interest rate and quantity of loanable funds would increase b. the interest rate and quantity of loanable funds would decrease. c. the interest rate would increase and the quantity of loanable funds would decrease. d. the interest rate would decrease and the quantity of loanable funds would increase.

d. the interest rate would decrease and the quantity of loanable funds would increase As an increase in max contributions would act as an incentive for increased saving, the quantity of loanable funds would increase (as savings = quantity of loanable funds)

Suppose the government were to replace the income tax with a consumption tax so that interest on savings was not taxed. The result would be that the interest rate a. and investment both would increase. b. and investment both would decrease. c. would increase and investment would decrease. d. would decrease and investment would increase.

d. would decrease and investment would increase As there is no tax on savings, consumers have an incentive to save more and investment would increase (as savings = investment).

What is fiscal policy?

government taxes, spending, and borrowing

What are financial markets?

they allow savers to directly provide funds to those who want funds; Stock Market

What is a budget deficit?

when a government spends more than what it receives in revenue