CH10 beginning

Question 1

financial markets

Answer 1

markets in which the government, firms and individuals trade promises to pay in future (instead of goods)

Question 2

savings-investment spending identity

Answer 2

savings and investment spending are always equal for the economy as a whole

Question 3

investment spending

Answer 3

spending/investing in new physical capital
–> only spending that adds to the economy’s stocl of physical capital is considered investment spending

Question 4

inflow of funds

Answer 4

foreign savings that finance investment spending in that country

Question 5

outflow of funds

Answer 5

domestic savings that finance investment spending in another country

Question 6

net capital inflow (equation)

Answer 6

total inflow of funds into a country– the total outflow of funds out of a country

Question 7

economy with positive net capital inflow…

Answer 7

some investment spending funded by savings of foreigners–> more capital flowing in than out

Question 8

economy with negative net capital inflow…

Answer 8

portion of national savings is funding investment spedning in other countries–> more capital flowing out than in

Question 9

for economy as a whole

Answer 9

savings=investment spending

Question 10

in closed economy

Answer 10

savings=national savings

Question 11

in open economy

Answer 11

savings=national savings+capital inflow

Question 12

loanable funds market

Answer 12

hypothetical market that illustrates the market outcome of the demand for funds generated by borrowers and the supply of funds provided by lenders

Question 13

equilibrium interest rate

Answer 13

the interest rate at which the quantity of loanable funds supplied equals the quantity of loanable funds demanded

Question 14

2 factors that cause shift of DEmand curve for loanable funds:

Answer 14

1. changes in perceived business opportunities
2. changes in government borrowing

Question 15

changes in perceived business opportunities (explain)

Answer 15

Change in beliefs about the payoff of investment spending can increase/decrease the amount of desired spending at any given interest rate
Example: in ‘90s great excitement about business possibilities created by the internet→ business rushed to invest in computer equipment, internet cables etc→ resulting in shift to right of demand curve for loanable funds

Question 16

changes in government borrowing (explain)

Answer 16

If government run a budget deficit can be major source of demand for loanable funds
–> Other things equal, government budget deficits tend to reduce overall spending→ shifts demand curve for loanable funds to right→ leads to higher interest wage→ and if interest rate rises, business cut back on their investment spending (which is bad for the economy)

Question 17

crowding out

Answer 17

occurs when government budget deficit drives up the interest rate and leads to reduced investment spending
–> crowding out may not occur when economy is depressed–> because less employment–> government spending can lead to higher incomes–> these might lead to increased savings at any given interest rate

Question 18

2 factors that shift Supply curve of loanable funds:

Answer 18

1. changes in private savings behaviour
2. changes in net capital inflow

Question 19

changes in private savings behaviour (explain)

Answer 19

can change at any given interest rate because of number of factors
–> example: following corona pandemic+concerns of growing recession households cut back on spending–> resulting in increase of savings–> shift of supply cirve of loanable funds to right

Question 20

changes in net capital inflows (explain)

Answer 20

capital flows in+out of country can change as investors perception of country changes
–> Example: in 1999 after creation of euro, large net capital inflow Greece because investors believed that because Greece’s adoption of euro as currency made it safe place to put their funds→ shift to right
→ however in 2009 worries about Greek government’s solvency (and that had been understating its debt) led to collapse in investor confidence→ shrinking of capital inflows→ resulting in shift of supply curve in Greek loanable funds market to left

Question 21

global loanable funds market

Answer 21

arises when international capital flows are so large that they equalise interest rates across countries

Question 22

fisher effect (definition)

Answer 22

an increase in expected future inflation drives up nominal interest rate, leaving the expected real interest rate unchanged
→ each additional percentage point of expected future inflation drives up the nominal interest rate by 1 percentage point
→ both lenders+borrowers base their decisions on expected real interest rate→ result: change in expected rate of inflation doesn’t affect the equilibrium quantity of loanable funds or the expected real interest wage→ all it affects is the equilibrium nominal interest rate

Question 23

financial markets (definition)

Answer 23

where households invest theur current+accumulated savings

Question 24

(a households) wealth (definition)

Answer 24

the value of accumulated savings

Question 25

financial asset

Answer 25

a paper claim that entitles the buyer to future income from the seller
–> like a loan

Question 26

physical asset (definition)

Answer 26

a tangible object that can be used to generate future income
–> like pre-existing house or piece of equipment–> purchasing physical asset gives owner right to dispose of object how they wish (like rent/sell it)

Question 27

investing (definition)

Answer 27

the purchase of a financial/physical asset

Question 28

investment spending (definition)

Answer 28

spend funds that add to the stock of physical capital in the economy

Question 29

liability

Answer 29

a requirement to pay income in the future
→ so if get a loan from your bank (financial asset) also creating a liability→ so even though loan is financial asset from banks pov, it’s a liability from your pov

Question 30

4 kinds of important financial assets:

Answer 30

1. loans
2. bonds
3. bank deposits

Question 31

3 tasks of financial system –> to enhance efficiency of financial markets+make more likely lenders+borrowers make mutually beneficial trades that make society as whole richer

Answer 31

1. reducing transaction costs’
2. reducing risk
3. providing liquidity

Question 32

transactional costs (definition)

Answer 32

the expenses of negotiating and executing a deal

Question 33

reducing transaction costs (explain)

Answer 33

When large business want to borrow money: either go bank or sell bonds in bond market→ obtaining loan from bank avoids large transaction costs because only involving one single borrower and one single lender→ and the bond market exists to allow companies to borrow large sums of money without incurring large transaction costs