Banks Flashcards
What is money?
A medium of exchange used to purchase goods and services
What does money allow to happen?
It allows purchasing power to be transferred among people
What is required for money to work?
Everyone to trust that everyone else will accept money as payment
What is M1?
Liquid wealth: money that is instantly available to be used for purchases (ie cash, coins, current accounts)
What is the definition of income?
The amount of money one receives over some period of time
What is the definition of wealth?
The stock of things owned, or the value of that stock
What is depreciation?
The reduction in value of a stock or wealth over time
What is net income?
The maximum amount that one could spend without running down wealth
Net income = gross income - depreciation
What are earnings?
Wages, salaries, and other incomes from labour
What are savings?
Savings are income that is not consumed
What is economic investment?
Expenditure on newly produced capital goods, such as machinery
What is the opportunity cost of having more goods?
Having more goods now comes with an opportunity cost of having fewer goods later
What do borrowing and lending allow?
They allow for one to rearrange their capacity to buy goods and services across time
What does borrowing allow?
More to be bought in the present at the expense of buying less in the future
What is interest rate?
The interest rate on borrowing money is equal to the price of brining buying power forward in time
What are the two factors that affect how much consumption an individual will move forward?
Consumption smoothing
Impatience
Why does an individual smooth their consumption?
So they avoid spending a lot in one period then little in another period
What is diminishing marginal returns to consumption?
The value of an additional unit of consumption declines, and depends on the consumption an individual has
What are the actions of a saver?
They smooth their consumption by postponing it to the future
What does lending money do?
Lending at interest expands the lenders feasible set as compared to just storing the money
What does investment do?
Allows consumption to be moved to the future
How can consumption be increased for both periods of high and low income?
By using a combination of both investing and borrowing money
What does a balance sheet do?
Summarises what a firm owns and what it owes to other
Net worth = assets - liabilities
What is a bank?
A firm that makes profit by borrowing and lending money
Where do banks borrow from?
Households (through deposits), other banks, and the central bank
How do banks make profit?
The interest they pay on the money they borrow is less than the interest they charge on money they lend, allowing them to make profit
What is base money?
The physical money, such as cash and coins. It is legal tender, so has to be accepted as payment by law
What is the central bank?
The banker for commercial banks, normally owned by the government, and the only bank in the country allowed to create legal tender
How can the central bank create money?
All commercial banks have an account at the central bank, and by crediting these accounts, the central bank is able to create legal tender
How do commercial banks create money?
They make loans by lending the money deposited into them, thus creating bank money, which is not legal tender
What is broad money?
The combined total of all money, including bank money and base money
Broad money = base money + bank money
What is a bank run?
A situation where all depositors demand their money at once. Bank runs can result in a bank failure, as there isn’t enough base money kept in a bank for this to happen.
As well as a bank run, what is the other way that a bank can fail?
By making bad investments, such as giving loans that don’t get paid back
Why may the government intervene when a bank fails?
A bank failure can bring down the financial market, such as in 2008
Why do those with less wealth often find it hard to borrow money?
They can struggle to provide equity or collateral, as they have limited wealth
What is credit rationing?
When those with less wealth:
Borrow on unfavourable terms compared to those borrowing with more wealth (credit-constrained)
Are refused loans completely (credit-excluded)
