Principles of Macroeconomics
Principles of Macroeconomics ECO 2013
Popular in Course
Popular in Economcs
verified elite notetaker
This 17 page Class Notes was uploaded by Stacey Bergstrom on Monday October 12, 2015. The Class Notes belongs to ECO 2013 at Florida International University taught by Prasad Bidarkota in Fall. Since its upload, it has received 19 views. For similar materials see /class/221807/eco-2013-florida-international-university in Economcs at Florida International University.
Reviews for Principles of Macroeconomics
Report this Material
What is Karma?
Karma is the currency of StudySoup.
You can buy or earn more Karma at anytime and redeem it for class notes, study guides, flashcards, and more!
Date Created: 10/12/15
CHAPTER 8 SAVING INVESTMENT AND THE FINANCIAL SYSTEM Review Problems 1 9 ll 12 This chapter examines how the nancial system works by describing various institutions investigating the relationship between the nancial system and key macroeconomic variables developing a model of supply and demand for funds in nancial markets Introduction The nancial system consists of those institutions in the economy that help to match one person39s saving with another person39s investment Interest rate is the price that adjusts supply and demand in nancial markets 131 Financial Institutions in the US Economy The nancial system moves resources om savers to borrowers De nition of nancial markets the institutions through which a person who wants to save can directly supply funds to a person who wants to borrow The Bond Market the market in which certi cates of indebtedness bonds are traded when companies wish to borrow money they do so by issuing a bond Three characteristics of a bond 1 term the length of time until the bond matures The longer the term of the bond the higher the interest rate 2 credit risk the probability that the borrower will fail to pay some of the interest or principal The probability that the borrower will default The lower the risk of default the lower the interest rate The higher the risk of default junk bonds the higher the interest rate 3tax treatment the way in Which the tax laws treat the interest earned on the bond municipal bonds are usually tax ee and have a lower interest rate De nition of bond nance the sale of bonds to raise money The Stock Market the market for stocks which represent ownership in a rm and are claims on the pro ts a rm makes De nition of equity nance the sale of stock to raise money Holding stocks represent ownership rather than supplying credit to the rm Stockholders earn pro t while bondholders are paid interest Stocks offer higher risk than bonds and therefore higher potential returns De nition ofsiock index a computed average of a group of stock prices The most famous one is the Dow Jones Industrial Average Stock prices are determined by the interaction of supply and demand in stock markets and re ect expectations of future pro tability They are watched closely as possible indicators of future economic conditions FYI How to Read the Newspaper39s Stock Tables This box describes price volume dividends and priceeamings ratio Financial Intermediaries Financial intermediaries are institutions which connect savers and borrowers There are two important kinds Banks take deposits om savers and make loans to borrowers Banks make money on the difference in the interest rate they pay on deposits and collect on loans They also provide a medium of exchange in the form of checkable deposits and a store of value for the wealth people accumulate 7 Mutual funds an institution that sells shares to the public and uses the proceeds to buy a portfolio of various types of stocks andor bonds They allow small investors to pool their funds to take advantage of risk diversi cation 132 Saving and Investment in the National Income Accounts The National Income accounts include GDP and the many related statistics Some Important Identities YCIGNX But in a closed economy Y C I G solYCGSavingSI 0rSYCG YTCTG private saving public saving 9 De nition of private saving the amount of income that households have left after paying their taxes and paying for their consumption De nition of public saving the amount of taX revenue that the government has left after paying for its spending De nition ofbudget surplus T gt G TG is public saving De nition ofbudget de cit G gt T The Meaning of Saving and Investment Investment refers to the purchase of new capital S I doesn39t have to be true for individuals but it is true economy wide 133 The Market for Loanable Funds Imagine a market for loanable funds where the interest rate is the price Demand is downward sloping and supply is upward sloping and the intersection of supply and demand represents an equilibrium real rate of interest See Figure 131 Policy 1 Taxes and Saving Saving is an important longrun determinant of a nation39s productivity Tax policies that encourage savings are consumption taxes and deductions for IRAs The supply of loanable funds would increase decreasing the interest rate and encouraging investment as well as saving Policy 2 Taxes and Investment Investment taX credits encourage rms to borrow to invest The demand for loanable funds increases Which raises the interest rate and encourages saving 12 Policy 3 Government Budget De cits When government borrows to spend more than it receives in revenue it reduces the supply of loanable funds making interest rates rise When the government reduces national saving by running a budget de cit the interest rate rises and investment falls This is called crowding out Case Study Government Debt and De cits in the US See Figure 135 The DebtGDP ratio has risen since the 198039s A large de cit crowds out private investment and reduces savings Though most government of cials agree that should be corrected it is dif cult because Clinton wants to raise taxes on the wealthy to do it but Congress wants to reduce taxes to encourage saving FYI Ricardian Equivalence An Alternative View of Government Budget De cits Named after 19th century economist David Ricardo The Rieardian Equivalence theory says that if people save their whole tax cut and government doesn39t change its spending that the government de cit doesn39t matter Why would they save their tax cut Ricardo said they would anticipate the higher taxes that would eventually be necessary because of the budget de cit History has not con rmed that consumers save tax cuts Instead as public saving is reduced so is private saving In the News The Balanced Budget Amendment Robert Eisner says the balanced budget is bad economics The federal government has no separate capital budget like most states do that have balanced budget amendments Households borrow to buy homes and pay for college and businesses borrow When they issue bonds 134 Conclusion The price of loanable funds is the interest rate and depends on the interactions between supply and demand Financial markets unlike other markets serve the important role of linking the present and the future
Are you sure you want to buy this material for
You're already Subscribed!
Looks like you've already subscribed to StudySoup, you won't need to purchase another subscription to get this material. To access this material simply click 'View Full Document'