Savings = Investment,
consumer savings disposable income= C + Sprivate
Government savings- Sgov=T-Tr-G. surplus>0
deficit ,<0 T< Tr+G .
(KI), IN- + funds moving
world to domestic
foreigners savings use domestic, OUT + funds moving domestic to world. KI= M-X=
savings foreigners, X-M< domestic borrows from world, X-M>0 world borrows.
market for loanable funds
one asset, price = interest rate (r,i) given as % so size
lenders choose how much to save given I, borrowers choose how much
to borrow given I, outcome efficient.
Rate of Return
(profit earned by firm on
investment as % of expenditure) > cost of loan,
RR= (marginal revenue from
investment – cost of investment)/cost of investment x 100, if RR>r then firm demands
funds RR<I t hen borrow 0.
downward sloping- I high only firms with large
RRs satisfy borrowers wants low#, as i deceases more firms have RR such that RR>i so
more firms borrow #
of loans increases.
PV of future income> PV of present
consumption then will supply S<B(1+r)S
B- consumer impatience. Tina has $1 to
spend or save
.8(1+.2).1= .96 <1 so tina spends, lowest interest rate to
i=25%. upward sloping consumers differ in impatience
is low only
most patient will save as i
increases more people satisfy so more save.
r* q* always in CE since S=I .
budget= T-TR-G <0 (deficit) people want
G and TR high T low, crowding out by decreas quantity of private loanable funds
available inefficient allocation funds, Consumption tax/reducing capital tax lowers
opportunity cost saving, (1-t)S<S<B(1+i)S inefficient
growth too fast, optimal tax zero.
- different i+
time horizons types assets. Financial asset ( loan stock
bond bank deposit) Physical asset (pre-existing house factory painting)
lender asset borrower liability assets= liabilities
Role of financial system
transaction costs (expense of negotiating and executing a trade) , liquidity (gives cash to
those who need it), reducing risk( uncertainty
future outcomes involves cost and
benefits opportunity to diversify).
Types of financial assets
- loan- agreement to lend
funds now in exchange for funds +interest later individually tailored high transactions
costs illiquid asset, bonds- firm or gove traded in market+ quality rated by independent