9 Capital Formation, Financial Markers and Money Supply Flashcards
Savings formula?
Current income - spending on Current needs
Saving rate formula?
Saving / income
Wealth formula?
Wealth refers to total value of all assets - liabilities
Includes tangibles assets and intangible assets, such as financial investments (stocks, bonds), intellectual property, and savings.
What is flow value? What is stock value?
Flow value: measured over a period of time (income & saving)
Stock value: defined at a point in time (wealth & debt)
Formula for change in wealth?
Change in wealth = Saving + Capital gains - Capital losses
Wealth changes when value of assets change
National Savings formula?
National Savings (S) determines a country’s ability to invest in new capital goods (produce more output in future). Contributed by households, business and government savings
Assume NX = 0
S= Y - C - G
(GDP - Consumption - Government purchases)
S = Current Income (GDP or Y) - spending on Current needs
- Excludes all Investment spendings (future needs)
Same formula but diff approach^
S = private savings + public savings
S = (Y - T - C) + (T - G)
S = Y - C - G
Private saving formula?
S private = Y - T - C
Private saving = AFTER-TAX INCOME - Consumption
Household’s total income (Y)
Private saving = Household + Business saving
Formula for net taxes for private savings?
Net taxes (T) = Taxes - Transfers
Govt transfer payments increase household income
- made by govt without receiving any goods in return
Business savings formula?
Revenue - operating costs - dividends to shareholders
Business savings can purchase new capital equipment - Investment
Public saving formula?
S public = T - G
Public saving (by govt) is the amt of public sector’s income (net taxes T) not spent on current needs (G)
What is government budget?
- Balanced budget: govt spendings = net tax receipts
- Govt budget SURPLUS: T - G (excess of govt net tax collections over spending). Occurs during expansion
- Govt budget DEFICIT: public dissavings (want govt to spend more on us but we are unwilling to pay more taxes). Occurs during recession
3 reasons for household saving? (private saving)
- Life-cycle saving (retirement, buy house, children’s uni fees)
- Precautionary saving (protection for losing jobs, medical emergency)
- Bequest saving (inheritance)
What are savings?
Financial assets that pay a return
- Saving and fixed deposits
- Bonds
- Stocks
real interest rate = nominal interest rate - rate of inflation
(high real interest rate - more returns)
Reasons of low savings?
- Generous safety measures
- Mortgages with small/ no down payment
- Confidence in prosperous future
- Increasing value of stocks and growing home values
- Readily available home equity loans
- Demonstration effect and status goods (buy what others have also)
What is investment?
The creation of new capital goods and housing (savings channeled to finance investments)
Cost-benefit principle
Cost: of using machine/capital
Benefit: value of marginal product of capital
2 important costs in the Investment decision?
- Price of capital goods
- Real interest rates
(both increase - lead to decrease in investment)
Value of marginal product of capital is its benefits. What do other costs include?
- Net of operating & maintenance expenses and of taxes on revenue generated
Increases benefits:
- Technical innovation
- Lower taxes
- Higher price of output
What is supply of savings (S)? Upward or downward sloping?
Amt of savings that would occur at each real interest rate (r)
Upward sloping
What is demand for investment (I)? Upward or downward sloping?
Amt of savings borrowed at each real interest rate
Downward sloping
Financial market x-axis and y-axis?
(x) Saving and investment
(y) Real interest rate
Downward sloping (Investment - I)
Upward sloping (Savings - S)
What is equilibrium interest rate?
Amt of saving = investment funds demanded (all investment comes from savings)
If r (real interest rate) above equilibrium: will have surplus of savings
What happens to graph when technology improves?
Demand curve (Investment) shifts right
(New technology raises marginal productivity of capital)
- Higher interest rate
- Higher levels of savings and investment
What happens to graph when govt budget deficit increases?
Supply curve (Savings) shift left
(National savings formed by private + public savings. Govt deficit reduce national savings)
- Higher interest rate
- Lower level of savings and investment
Private investment is hence crowded out - negative budget decision of govt discourages private investment
How to increase national saving? 2 ways (have higher investment & growth rates)
- Reduce govt budget deficit
- Increase incentives for households (consumption tax, reduce taxes on investment income)
Higher national saving rate- greater investment in new capital goods - higher standard of living
What are financial intermediaries?
Firms that extend credit to borrowers using funds raised from savers
What are bonds? What does it consist of?
A legal promise to repay a debt
- Principal amount
- Maturation date
- Coupon payments (if u buy my bond, I will reward u w a certain amt every period)
- Coupon rate (interest rate applied to principal to determine coupon payments)
What does coupon rate depend on? 3 factors
- Bond’s term (longer, higher risk, higher coupon rate)
- Issuer’s credit risk
- Tax treatment for coupon payments (Government bond - safer - coupon bond not flexible - need lower coupon rate to attract people to buy
Private bond - coupon payment more flexible)
How to make bond more attractive compared to competitors?
Lower bond price
bond price x market interest rate = final payment (principal + coupon payment)
Lower bond price by how much? according to market interest rate, find final payment then work backwards to calc new bond price
Bond price & interest rates are inversely related (drops & increase, vice versa)
What are stocks?
A claim to partial ownership of firm
2 reasons for buying company’s shares:
- Receive dividends (when company makes profit)
- Receive capital gains (selling next year at higher price)
When will value of stock be higher?
Stock price x interest rate = selling price of stock + dividend
- Dividend higher
- Price of stock in future higher
- Interest rate LOWER
What is risk premium?
Rate of return investors require to hold RISKY assets - rate of return on safe assets
Buying shares riskier than bonds
When calculating, use risk premium % not market interest rate %
Risk aversion (increase/decrease) the return required of a risky stock and (increase/ lower) selling price
Increase
Lower
What are the 3 principal uses of money?
