Chapter 10 Flashcards
Savings-Investment Spending Identity
Savings and Investment spendings are always equal
who pays for private investment spendings?
individuals create capital with other people’s money and savings
Investment Spending in a closed economy (2)
no imports or exports (no trade)
savings=investment spendings
why does income of economy=spending in a closed economy?
one person’s spendings is another person’s income
Total Income Equation
GDP=C+G+S
Total Spendings Equation
GDP=C+G+I
Budget Surplus
Tax Revenue > Government Spendings= high savings
Budget Deficit
Tax Revenue < Government Spendings= low savings
Budget Balance
Difference between tax revenue and government spending, positive=surplus, negative=deficit
National Savings
Sum of private savings(household) (GDP-T+TR-C) and public savings(government)
Investment Spending Identity in open economy (2)
- open to trade so money flows in and out
- savings of people in one country can be used to finance investment spendings in another
3 types of capital and description
physical - manufactured aids ex machine
human - education and skills and knowledge of labour force ex university
financial - funds from savings used for investments ex stocks
Inflow of Funds (capital inflows)
Foreign savings that finance domestic investment
outflow of funds (capital outflows)
domestic savings that finance foreign investment
Net Foreign Investment
total outflow of funds - total inflow of funds
NFI<0 (2)
- foreigners invest more on country then country invest more on other countries
- country borrows funds
In a open economy savings=
investments plus net foreign investments
Financial Markets
Channel savings of households as investments to businesses that want to borrow money so they can invest
loanable funds market
simplified financial market with one interest rate, where suppliers of funds come together with borrowers of funds
price of a loan is the
nominal interest rate: what loaner chargers for when they lend funds
Demand for loanable funds graphical analysis
interest rate is low, more funds demanded as less interest to pay back
interest rate is high less funds demanded as person needs to pay back more interest so they would rather loan their funds to gain interest
supply of loanable funds graphical analysis
interest rate is high- more beneficial for lender to lend funds and gain interest
interest rate is low- more beneficial for lenders to invest in project or borrow funds
At the Equilibrium interest rate (return rate) (3)
the right projects are funded when they are profitable at interest rate higher or equal to eqbm
- right people do savings when lenders charge eqbm interest or less
when demand curve of loanable funds is higher then market eqbm interest rate (top left)
projects interest rate (project return) is higher then the loan interest rate price so firms will invest and take out a loan to finance project
when demand curve of loanable funds is lower then market eqbm interest rate (bottom right)
the interest rate (return of project) is lower then the market interest rate price, so firms do not take out a loan to finance the project
when supply curve of loanable funds is higher then market interest rate (top right)
supplier is offering interest rate higher then market so borrowers do not accept loans
when supply curve of loanable funds is lower then market interest rate
supplier if offering interest rate lower then market so borrowers accept loans
factors that can cause demand curve for loanable funds to shift (2)
- changes in perceived business opportunities
- changes in gov policies
demand shifting to right (2)
- tax credit for investment
- borrows can accept funds at higher interest then before because projects are returning better then before (can still make money at higher interest)
shift of supply of funds (2)
- change in private savings
- change in government budget balance
change in private savings supply shift
people save more so less funds available to loan so shift left (people think inflation could beat interest)
people save less so more funds available to loan so shift right (house gets bonus cheque)
crowding out and shift of supply of loanable funds
occurs when budget balance is negative, gov needs to borrow funds so supply of loanable funds shift left as less funds available for consumers (less investment spending), this also causes interest rate to increase
crowding out shifts supply to the____ and demand to the ____ and how to reduce a deficit the demand curve would have to shift
left, right,left
global loanable funds market
equalizes interest rate across countries
canada interest rate is 6% and britains is 2% what will happen for global investing and borrowing
canada will borrow from britain instead of canada as they can pay back interest at lower rate
people in britain will loan to canada instead of britain as they can charge higher interest on their loans
when global interest rate is lower then domestic interest rate
demand of funds increase down the curve, loaners don’t want to loan as much funds now as the interest rate fell, this creates excess demand so country needs capital inflow
when global interest rate is higher then domestic interest
demand of funds decreased up the curve, loaners want to loan more funds as higher rate of return, there is excess supply of loans which is loaned to other country as capital outflow
changes in interest rate shift what and are caused by (3)
- shift of supply and demand
- changes in gov policy
- expectations of future inflation
real interest rate equation and is also known as the true
nominal interest rate - inflation rate (true cost of borrowing)
do loan contracts specify inflation rate
no because no one knows inflation rate so they express nominal interest rate
Fisher Effect and how it drives nominal interest rate
does the real interest rate fluctuate or is it fixed (slides 29 and 30)
real interest rate is unaffected by changes in expected future inflation (it is fixed after changes)
ex expected high inflation increases nominal interest rate
financial system (4) and description of each
- wealth: value of HH accumulated savings
- financial asset: paper claim that entitles buyer to future income from seller
- physical asset: object that can be used to make future income
- liability: requirement to pay income in future
well functioning financial system
- critical for achieving growth
- channels savings into investment efficiently
present value of x in the future and formula
how much money persons needs to take out x in the future after gaining interest. PV=FV/((1+r)^t)
firms invest if…….. and meaning
present value of a future return is > the current value of investment for the same future return
- meaning instead of lending funds they invest money as its cheaper for the return
