chapter 10 Flashcards
define
Investment-savings relationship
in closed economy, no gov
savings = investment
define
Investment-savings relationship
in closed economy with gov
national savings = private + public savings
define
Private and Public Savings
equations
Pvt = Y - (T - TR) - C
Pub = revenue - expenditure, (T - TR) - G
T - TR is net tax revenue
define
investment-savings relationship
open economy
national savings = I + NX
something
Net Foriegn Investment
NFI = outflow of funds - inflow of funds
Sntl - I = NFI
X - M
define
Outflow
NFI
Investment in foreign firms causing funds to leave the economy
define
Inflow
NFI
foreigners can buy goods and services, causing funds to enter the economy
relationship between I, Sntl, and NFi
NFI = Sntl - I
I = Sntl - NFI
Sntl = I + NFi
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
What is demand and supply in the loanable funds market?
S: quantity of funds, primarily from households
D: demand for borrowing funds
x and y axis of loanable funds mkt
x: quantity of loanable funds
y: interest rate
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
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
define
present value calculation
A = B / (1 + i)
or
X = (expected return/(1+i)^t) - initial cost
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
list
Supply side of loanable funds mkt
based on:
- household decisions to save
- gov saving
- as interest rate increases, households save more
discuss
eqm of loanable funds mkt
investment = savings
discuss
excess supply of funds in the loanable funds mkt
downward pressure is put on the interest rate
discuss
excess demand in loanable funds mkt
firms compete for borrowing, leading to a higher interest rate
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
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
dicuss
changes in gov policy
- tax credit: whichever firms invest will get to pay less taxes
- investment subsidies
both cause demand to shift right
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
