Savings, Investments, and Capital Markets Notes (ECON E-202; Introduction to Macroeconomics; Wenyi S

Savings, Investments, and Capital Markets Notes (ECON E-202; Introduction to Macroeconomics; Wenyi S

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Unformatted text preview: Savings, Investment & Financial Markets Chapter Outline ' The Financial System ° Savings and Investment ' Loanable Funds Market _ffl_,,_____ \M The Financial System ° Sources of Borrowing - Indirect finance: A flow of funds from savers to borrowers Hmvflh financed [/1 remedrarfés - Direct finance: A flow of funds from savers to firms throughm bond 5M9 The Financial System ' Financial system: - The system of financial markets and financial intermediaries through which firms acquire funds from households 0 Financial markets — Markets Where financial securities, such as stocks and bonds, are bought and sold 0 Financial intermediaries - Firms, such as banks, mutual funds, pension funds, and insurance companies, that borrow funds from savers and lend them to borrowers The Financial System: Bond & Stock Markets ° The bond market 3:?“ — Bond: A financial security that represents a promise to repay a 9er amount of funds T he stock market - Stock: a financial security that represent Era/gal ownershfg 0f the firm The Financial System: Mutual Funds & Banks ° Mutual Funds - An institution that sells shares to the savers Signal-"5 give. W5 ° Banks - Take deposits from people who want to save - Pay depositors interest and charge borrowers slightly WSW interest rate The Financial System The financial system provides three key services for savers and borrowers: ° Risk sharing - Liflw’ciitr (i.e., the ease with which a financial security can be exchanged for money). ' Information Saving & Investment Let’s look at an aggregation of all savers and users of funds. Saving (S) and investment (I): ‘Consider an econom with constant y population, full employment, and no foreign sector. 81m .' GvF"—c UFO For individuals, earned income (Y) along With transfers (TR) from the government is used to buy consumption goods (C), private savings (Sprivate), or pay taxes (T). ,3 So,%{+TR=T+C+S And sprivate = Y + TR“ T — C private Saving & Investment Government savings is, Spublic = T -— G - So total savings (S) is Sprivate + Spuinc S=[Y+TR—C—~T]+[T—G—TR] The total value of saving in the economy must / the total value of investment Question: Y = $12 trillion C = $8 trillion 1: $4 trillion TR = $2 trillion T = $3 trillion Based on the information above, What is the level of private saving in the economy? \{ ,r Tia—T -C =\1+1'3 ‘3’ ‘- AS WWW Based on the information above, what is the level of public saving? 3 \{W fewer“; :. 5—0—2 = lt‘r“\°’ Loanable Funds Market The Loanable Funds Market is an arrangement through which households make their savings available to borrowers. /— 0 Supply of funds is the sum of household saving and government’s budget surplus (if any). mavwi /. 0 Demand of funds is the sum of the business sector’s planned investment spending and the government sector’s budget deficit (if any). 10 Loanable Funds Market Supply of funds curve indicates the level of household saving at various interest rates. The quantity of funds supplied depends positively on the interest rate. The higher the real interest rate, the gfeokP/F is a household’s opportunity cost of consumption and so the larger is the amount of saving (movement on). 11 Loanable Funds Market Supply of funds curve (r){eg,\ I'Aeri' (“3m Z—F Shifts of the savings curve {lemme mm WW— 0 Disposable income 1* d? shims “BM ° Household’s éxgao’xd future income t Sam mm mm \an 12 Loanable Funds Market Investment demand curve indicates the level of investment spending firms plan at various interest rates. The quantity of funds demanded depends negatively on the interest rate. Government demand for funds curve indicates the amount of government borrowing. It is independent of the interest rate. Total demand for fund curve is the total amount of borrowing at various interest rates. 13 Loanable Funds Market Igestment demand curve \‘flow’ W" { . 14 Loanable Funds Market Business investment decisions are influenced by: The expected profit rate: The expected profit rate is relatively high during expansions and relatively low during recessions. b.6945: Increases in technology caifllcrease the expected profit rate. Taxes affect the expected profit rate because firms are concerned about the after-tax profit rate. The real interest rate: The real interest rate is the opportunity cost of investment. An increase in the real interest rate decreases the number of investment projects that are profitable. 15 Loanable Funds Market: Demand and Supply _ 16 Loanable Funds Market: Explaining Movements in Saving, Investment, and Interest Rates: a shift from an income tax to a consumption tax \cts CL/ / 30??“ Qud‘ Ve. Shiclts 5m: . wéubow“ figfiw I 17 Loanable Funds Market: Explaining Movements in Saving, Investment, and Interest Rates: l'yxMM-éels The government a budget deficit d3 mound Cofu'fl 6hi'Hg It, 18 Loanable Funds Market: Explaining Movements in Saving, Investment, and Interest Rates: Taxes are changed so that real interest income is taxed rather than nominal interest inceme f managed flaw/cal Mir?" fade in Hwa route, ('2 7’) Wbmimi (Mans? “03“” 3 a] too YS'fr‘” 5 100x37r *3 / 19 \Z Loanable Funds Market: Explaining Crowding Out Effect Assume that the country of Wylieton is initially has a budget deficit of $ 20 billion. Then Wylieton’s government decides to conduct fiscal policy and increase government spending by $20 billion. Discuss and illustrate the effects of Wylieton‘s government action in a diagram of the Loanable funds market and discuss its effects on total spending. You need to fully label your diagram and all important points, curves, axes, and indicate the direction of any shift. You also need to fully discuss each shift and movement made along with defining the term “crowding out” and how it is applied here. Loanable funds Market diagram gfor full credit all parts must be labeledl .5- D 7 K filth“ Explanation New Equilibrium Reason Why (increase, decrease, remain the same, or ambiguous) WWW Consumption Private savings fl Planned Investment Discuss what is crowding out and how much WES-bat face-f M‘Mv‘ smwt mm} {MAM Ab Mfg” “it Mam}: 20 ...
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This note was uploaded on 12/21/2011 for the course BUS 100 taught by Professor Intro during the Fall '11 term at UCSB.

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Savings, Investments, and Capital Markets Notes (ECON E-202; Introduction to Macroeconomics; Wenyi S

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