chapter 10 Flashcards by Uby W

define

Investment-savings relationship

in closed economy, no gov

savings = investment

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define

Investment-savings relationship

in closed economy with gov

national savings = private + public savings

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define

Private and Public Savings

equations

Pvt = Y - (T - TR) - C
Pub = revenue - expenditure, (T - TR) - G

T - TR is net tax revenue

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define

investment-savings relationship

open economy

national savings = I + NX

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something

Net Foriegn Investment

NFI = outflow of funds - inflow of funds
Sntl - I = NFI
X - M

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define

Outflow

NFI

Investment in foreign firms causing funds to leave the economy

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define

Inflow

NFI

foreigners can buy goods and services, causing funds to enter the economy

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relationship between I, Sntl, and NFi

NFI = Sntl - I
I = Sntl - NFI
Sntl = I + NFi

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define

What does it mean if NFI is negative or positive?

Negative: more funds flowing out
Positive: more funds flowing in

positive NX -> pos NFI, vice versa

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What is demand and supply in the loanable funds market?

S: quantity of funds, primarily from households
D: demand for borrowing funds

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x and y axis of loanable funds mkt

x: quantity of loanable funds
y: interest rate

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opportunity costs in the loanable funds mkt

investment is based on own savings
investments are based 100% on borrowing: firm will have to pay it back, the amount is dependent on interest rate

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firms will borrow when

the expected return from the project > amount they’ll pay back
equation: A (1+i) = B

A = present value/investment amount,
B = amount to be paid back

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define

present value calculation

A = B / (1 + i)
or
X = (expected return/(1+i)^t) - initial cost

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how to find out the max amount a firm should borrow?

look at the expected return based on interest rate
expected return/(1+i) = max amount willing to borrow

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list

Supply side of loanable funds mkt

based on:
- household decisions to save
- gov saving
- as interest rate increases, households save more

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discuss

eqm of loanable funds mkt

investment = savings

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discuss

excess supply of funds in the loanable funds mkt

downward pressure is put on the interest rate

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discuss

excess demand in loanable funds mkt

firms compete for borrowing, leading to a higher interest rate

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list

causes of shifts in the demand curve (loanable funds)

changes in perceived business profitability and/or opportunities
changes in government policy that affects investment decisions

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discuss

changes in percieved profitability

increased demand for borrowing: shift D right
can also cause D to shift left (ex. noticing that businesses are failing)
triggered by changes in technoogy and resources

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dicuss

changes in gov policy

tax credit: whichever firms invest will get to pay less taxes
investment subsidies
both cause demand to shift right

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discuss

What happens when demand shifts right?

rise in eqm interest rate
increase in demand for funds
quantity saved increases

discuss

causes of shifts in supply curve (loanable funds)

changes in private saving behavior
- based on predicted future -> change in output, savings inc, supply curve shifts right
- hopeful about future, cut savings, supply curve shifts left
Changes in gov budget balance
- budget surplus: Spub is positive, more investment
- budget deficit: Spub is negative, reduction of savings, reduce loanable funds (left)

# discuss What happens when supply shifts right or left? (loanable funds)

right: interest rate dec, quanitity supplied inc left: rise in eqm interest rate, quantitiy dec

# define Budget Balance

revenue - expenditure (Tax - TR) - G

# discuss (T - TR) - G = 0...

T - TR = G budget is balanced, and no public savings are present

# discuss (T - TR) - G > 0...

budget surplus Spub > 0

# discuss (T - TR) - G < 0...

budget deficit government is spending more than is earned from taxes Spub < 0

# discuss Global Market for Loanable Funds

factors: interest rate differential (local v global), risk status, exchange rate, etc. high interest rate in world mkt causes outflow, low world interest rate causes inflow from abroad

# discuss risks in global market

volatile political environment currency values

# discuss Capital Flows

- countries with low interest rates have capital flow into those with higher interest rates - lenders intrested in higher interest rate -> creates competition - borrowers interested in lower interest rate -> competition - raises interest rate in lower country, reduces it in higher interest rate country - high interest rate country will have excess demand - low interest rate country will have excess supply

# discuss what a bond is

a bond is issued by the government and firms to borrow money from the economy

# define face value | bonds

amount being borrowed and the price of a bond when issued

# define years of maturity | bonds

when you'll get back the money from the bond (can be short or long term)

# define coupon value

fixed coupon allowing you to get fixed cash back after each year

# define bond yield

return expected after each year until maturity (?)

Where can you sell bonds?

bonds market!

relationship between price of a bond and the nominal interest rate is...

inverse! - if nominal interest rate rises, bond price falls - if nominal interest rate rises, bond price rises

# discuss fisher effect and loanable funds mkt

eqm in loanable funds mky corresponds o *expected inflation*, a change in *expected inflation* shifts both demand and supply *equally* and simultaneously. This leads to a new nominal interest rate in the loanable funds market, the eqm quantity *does not change* what really matters is *real interest rate*, it tells us what happens to *purchasing power* real interest rate = nominal interest rate - inflation rate

# discuss significance of fisher effect

our expectation of inflation shifts with the economy, and unions base wage negotiations on expected inflation basically both demand and supply shift upward

Savings-Investment Spending Identity

savings = investment spending

Snational = | closed economy

GDP - C - G

TR | what does it represent

TRANSFERS

Sprivate =

(GDP - T + TR) - C

# define Present Value

the amount of money needed today in order to receive X at a future date, given the interest rate

if interest rate falls... | loanable funds

present value rises, more projects have a greater future payoff

if interest rate rises... | loanable funds

present value falls, less projects have greater future payoff = less investment

# define crowding out

the negative effect of budget deficits on private investment - gov brrowing drives up interest rate

# define Fisher Effect

the expected real interest rate is unaffected by changes in expected future inflation

How to calculate Present Value of One-Year Projects

X x (1 + r) = amount recieved X = amount recieved/(1 + r) | where X is amount lended

How to calculate the Present Value of Multiyear Projects

Xnyrs x (1 + r)^n = amount recieved Xnyrs = amount recieved/(1 + r)^n

How to calculate Present Value of Projects with Revenues and Costs

X = (revenue/(1 + r)^n) - initial cost

How to Calculate thr Price of a Bond Using Present Value

Bond Price = C/(1 + i) + C/(1 + i)^2 + ... + C/(1 + i)^(n - 1) + C/(1 + i)^n + F(1 + i)^n where C = coupon i = interest rate n = number of years F = face value

Investment Spending = | closed economy

GDP - C - G

Net Capital Inflow

inflow - outflow M - X