Ch. 9 Saving, Investment, and the Financial System Flashcards
Saving definition
Income that is not spend on consumption goods
Investment definition
purchase of new capital: tools, machinery, factories.
what determines the supply of savings?
- smoothing consumption
- impatience
- market and psychological factors
- interest rates
Why do individuals want to smooth consumption?
- To save during working years to provide for retirement.
2. Manage fluctuations in income (save during good times to ride out bad times)
Time preference definition
the desire to have goods and services sooner rather than later
What happens as the interest rate increases?
the greater the quantity saved, but the smaller the quantity demanded of savings will be
What determines the demand for savings?
- smoothing consumption
- Financing large investments
- the interest rate
What is the Lifecycle Theory of Saving?
By borrowing, saving, and dissaving at different times in life, workers can smooth their consumption path, improving their overall satisfaction.
Why is borrowing necessary?
To finance large investments, such as education, new apartment buildings, and highway systems
When is an investment profitable?
if its rate of return is greater than the interest rate
When does a market for loanable funds occur? What does it determine?
when suppliers of loanable funds (savers) trade with demanders of loanable funds (borrowers); determines the EQ interest rate and the EQ quanitity of savings/borrowing
What are the three financial intermediaries and what to they do?
Banks, bond market, and stock market. They reduce the costs of moving savings from savers to borrowers and investors.
What do banks do?
- gather savings
- reduce cost of mobilizing savings to productive uses
- spread risk
What is a bond?
a sophisticated IOU that documents who owns how much and when payment must be paid
What happens when a risk of a bond increases?
the greater the interest rate required to get lenders to buy the bonds, also higher risk means higher return
