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Class%20#2%20461%20Fin%20Intermed0 - Direct Finance and...

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Direct Finance and Financial Intermediation
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2 Current Events Presentation TODAY: Me THURSDAY: Volunteer Assignment: Text, Chapter 2 (for the next class)
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3 Class Outline 1. The circular flow of spending 2. Saving (S) and investment (I) 3. Financial assets and the movement of funds—direct finance 4. Problems in direct finance 5. Indirect finance—intermediaries
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4 1. The circular flow of spending The financial sector of an economy exists to serve the real sector . The real sector of the economy is what is important to everyone (their economic welfare )—measured by income, employment, unemployment, total spending, etc. Let’s set the context for the financial sector by using a simple model of a real economy. Skip a barter economy; go directly to a monetary economy There are only two sectors in the model (households and businesses); no government, no foreign sector The model will show the circular flow of spending
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5 HOUSEHOLDS BUSINESSES
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6 2. Saving (S) and investment (I) Saving is the act of not spending . In the model it is expressed as a leakage from the flow of income and is done only by households (a simplification). Saving (S) is income (Y) that is not spent.
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7 Saving Income is either spent (C) or not spent (S) so Y = C + S or S = Y - C The model does not address what happens to saving or where it goes ; it is simply income that is not spent In reality, businesses also save . They earn profits that are reinvested in the business (retained earnings) and their cash flow is larger than net income due to non cash flows like depreciation
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8 Investment Investment refers to factors of production that are used to produce goods that are not sold in the current period —capital goods (plant and equipment) or inventories of products. So investment (I) is shown as a leakage from the flow of factor inputs for the business sector.
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9 The model does not address how investment is paid for (or financed) In reality households also invest , for example in housing and durable goods The production (goods sold) by businesses (GDP or Y) is diminished by the amount of investment (I) so Y = C + I and I = Y - C Ex post , S = I since each equals Y – C. The leakages to S and I must be equal amounts. An equilibrium condition.
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10 Financial sector The financial sector of an economy is the mechanism by which funds get moved from saving (and savers) to investment (to investors in real assets, capital goods). The financial sector consists of the markets, institutions, and participating firms and principals (the financial apparatus ) to get this task done.
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