Chapter 10

Question 1

Savings-investment spending identity

Answer 1

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

Question 2

Budget surplus

Answer 2

The difference between tax revenue and government spending when tax revenue exceeds government spending

Question 3

Budget deficit

Answer 3

The difference between tax revenue and government spending when government spending exceeds tax revenue

Question 4

Budget balance

Answer 4

The difference between tax revenue and government spending

Question 5

National savings

Answer 5

The sum of private savings and the budget balance, is the total amount of savings generated within the economy

Savings (national) = savings (government) + savings (private)

Question 6

“investment spending”

Answer 6

spendingon new physical capital

Question 7

“making an investment”

Answer 7

The act of purchasing an asset such as a share of stock, a bond, or existing real estate

Question 8

net capital inflow

Answer 8

The total inflow of funds into a country minus the total outflow of funds out of a country

Question 9

national cost

Answer 9

the interest that must eventually be paid to a foreigner

dollar ofinvestment spending financed by a capital inflow > dollar investment spending financed by national savings

Question 10

Net capital inflow formula

Answer 10

Net capital inflow = imports - exports

Question 11

Investment spending formula (with capital inflow)

Answer 11

Investment Spending = National Savings + Net capital inflow

Question 12

Savings in a closed economy

Answer 12

Savings = National savings

Question 13

Open economy savings

Answer 13

Savings = national savings + capital inflow

Question 14

lonable funds market

Answer 14

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

Question 15

present value

Answer 15

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

Question 16

present value formula

Answer 16

X = 1,000 / (1 + r)

1,000 is money you want to have in one year

x = present value of money

r = interest rate

Question 17

Cause demand curve for lonable funds to shift

Answer 17

Changes in perceived business opportunities

Changes in government borrowing

Question 18

crowding out

Answer 18

Occurs when a government budget deficit drives up the interest rate and leads to reduced investment spending

Question 19

Shifts of the supply of Lonable funds

Answer 19

Changes in private savings behavior

Changes in net capital inflows

Question 20

Real interest rate =

Answer 20

Real interest rate = nominal interest rate - inflation rate

Question 21

Fisher effect

Answer 21

An increase in expected future inflation drives up the nominal interest rate, leaving the expected real interest rate unchanged

Question 22

wealth

Answer 22

the value of its accumulated savings

Question 23

financial asset

Answer 23

a paper claim that entitles the buyer to future income from the seller

Question 24

physical asset

Answer 24

a tangible object that can be used to generate future income

Question 25

liability

Answer 25

a requirement to pay income in the future

Question 26

4 types of financial assets

Answer 26

Loans

stocks

bonds

bank deposits

Question 27

3 problems for borrowers and lenders

Answer 27

transaction costs

risk

desire for liquidity

Question 28

transaction costs

Answer 28

the expenses of negotiating and executing a deal

Question 29

risk-averse

Answer 29

a person who is more sensitive to a loss than to a gain of an equal dollar

Question 30

diversification

Answer 30

Investing in several different things so that the possible losses are independent events

Question 31

liquid

Answer 31

If an asset can be quickly converted into cash with relatively little loss of value

Question 32

illiquid

Answer 32

An asset that cannot be quickly converted into cash with relatively little loss of value

Question 33

loan

Answer 33

a lending agreement between an individual lender and an individual borrower

Question 34

default

Answer 34

Occurs when a borrower fails to make payments as specified by the loan or bond contract

Question 35

securitization

Answer 35

process of pooling individual loans and selling shares in that pool

Question 36

loan-backed security

Answer 36

An asset created by pooling individual loans and selling shares in that pool

Question 37

Financial intermediary

Answer 37

An institution that transforms the funds it gathers from many individuals into financial assets

Question 38

Types of financial intermediaries

Answer 38

mutual funds

pension funds

life insurance companies

banks

Question 39

pension fund

Answer 39

A type of mutual fund that holds assets in order to provide retirement income to its members

Question 40

Life insurance company

Answer 40

Sells policies that guarantee a payment to a policyholder’s beneficiaries when the policyholder dies

Question 41

bank deposit

Answer 41

A claim on a bank that obliges the bank to give the depositor his or her cash when demanded

Question 42

Bank

Answer 42

a financial intermediary that provides liquid assets in the form of bank deposits to lenders and uses those funds to finance the illiquid investment spending needs of borrowers

Question 43

efficient markets hypothesis

Answer 43

Asset prices embody all publicly available information

Question 44

random walk

Answer 44

the movement over time of an unpredictable variable

Question 45

behavioral finance

Answer 45

The study of how investors in financial markets often make predictably irrational choices

Question 46

loss aversion

Answer 46

unwilling to sell an unprofitable asset and accept the loss

Question 47

herd mentality

Answer 47

buyinig an asset when its price has already been driven high and selling it when its price has already been driven low