Chapter 23: Finance, Savings and Investment

Question 0

Study of Money

Answer 0

Looks at how households and firms use it and how much of it they hold, how banks create and manage it and how its quantity influences the economy.

Question 1

Study of Finance

Answer 1

Looks at how households and firms obtain and use financial resources and how they cope with the risks that arise in this activity.

Question 2

Physical Capital:

Answer 2

Tools, instruments, machines, buildings and other items that have been produced in the past and that are used today to produce goods and services.

Question 3

Financial Capital:

Answer 3

Funds that firms use to buy physical capital.

Question 4

Gross Investment:

Answer 4

Total amount spent on purchases of new capital and on replacing depreciated capital.

Question 5

Depreciation:

Answer 5

Decrease in the quantity of capital that results from wear and tear and obsolescence.

Question 6

Net Investment:

Answer 6

Change in the quantity of Capital.

Net Investment = Gross Investment - Depreciation.

Question 7

Wealth:

Answer 7

Value of all the things that people own.

Question 8

Savings:

Answer 8

Amount of income that is not paid in taxes or spent on consumption goods and services.
Savings increase wealth.

Question 9

How do Wealth increase?

Answer 9

Wealth increases from savings. As well, it also increases when the market value of assets rises, called Capital Gains. And decreases when the market value of asset falls, called Capital Losses.

Question 10

Financial Capital Markets:

Saving is the source

Answer 10

Savings is the source that funds financial investment.
These funds are supplied and demanded in three types of financial markets:
Loan Markets
Stock Markets
Bond Markets.

Question 11

Financial Institution: Definition and key financial institutions:

Answer 11

Firm that operates on both sides of the markets for financial capital. It is a borrower in one market and a lender in another.

Commercial Banks
Government Sponsored mortgage lenders
Pension Funds
Insurance Companies.

Question 12

What is a financial Institute’s Net Worth?

Answer 12

It’s net worth is the total market value of what it has lent minus the market value of what it has borrowed. If net worth is positive, the institution is solvent and can remain in business.
If net worth is negative, it is insolvent and go out of business.

Question 13

Interest Rate on a financial asset:

Answer 13

Is the interest received expressed as a percentage of the price of the asset.

Question 14

Market of loanable funds:

Answer 14

Aggregate of all the individual financial markets.

Question 15

Funds that Finance Investment: Funds come from three sources:

Answer 15

1. Household savings S
2. Government Budget Surplus (T-G)
3. Borrowing from the rest of the world (M-X)

Question 16

Nominal Interest Rate:

Answer 16

Number of dollars that a borrower pays and a lender receives in interest in a year expressed as a percentage of the number of dollars borrowed and lent.

Question 17

Real Interest Rate:

Answer 17

Nominal Interest Rate adjusted to remove the effects of inflation on the buying power of money.
Real interest rate is approx equal to nominal interest rate minus the inflation rate.
Real interest rate is the opportunity cost of borrowing.

Question 18

Market for loanable funds:

Answer 18

Market for loanable funds determines the real interest rate, the quantity of funds loaned, saving, and investment.

Question 19

Quantity of loanable funds demanded depends on:

Answer 19

1. Real interest rate

2. Expected Profit.

Question 20

Demand for Loanable funds is the relationship between:

Answer 20

Between quantity of loanable funds demanded and real interest rate when all other influences on borrowing plans remain the same.
Business investment is the main item that makes up the demand for loanable funds.

Question 21

Market for loanable funds curve, rising and falling:

Answer 21

A rise in the real interest rate decreases the quantity of loanable funds demanded.
Fall in the real interest rate increases the quantity of loanable funds demanded.

Question 22

Changes in the Demand for Loanable funds:

Answer 22

When the ‘expected profit changes, the demand for loanable funds changes. Other things remaining the same, the greater the expected profit from new capital, the greater the amount of investment and the greater the demand for loanable funds.

Question 23

Supply of loanable funds:

Quantity of Loanable funds supplied depends on:

Answer 23

1. Real interest Rate
2. Disposable Income
3. Expected future income
4. Wealth
5. Default risk

Question 24

Supply of Loanable funds is the relationship between:

Answer 24

Quantity of loanable funds supplied and the real interest rate when all other influences on lending plans remain the same.
*Saving is the main item that makes up the supply of loanable funds.

Question 25

Rising and falling of the supply of the loanable funds curve:

Answer 25

Rise in the real interest rate increases the quantity of loanable funds supplied.
Fall in the real interest rate decreases the quantity of loanable funds supplied.

Question 26

Changes in the Supply of loanable funds:

Answer 26

A change in disposable income, expected future income, wealth, or default risk changes the supply of loanable funds.
An increase in disposable income, a decrease in expected future income, a decrease in wealth or a fall in default risk increases saving and increases the supply of loanable funds.

Question 27

Equilibrium for the loanable funds market:

Answer 27

A loanable funds market is in equilibrium at the real interest rate at which the quantity of loanable funds demanded equals the quantity of loanable funds supplied.

Question 28

Changes in Demand and Supply of the Loanable Funds Market:

Answer 28

Financial Markets are highly volatile in the short run, but stable in the long run.
Volatility comes from fluctuations in either the demand for loanable funds or the supply of loanable funds.
These fluctuations bring fluctuations in the real interest rate and in the equilibrium quantity of funds lent and borrowed.
They also bring fluctuations in asset prices.

Question 29

Increase in demand for loanable funds

Answer 29

An increase in expected profits increases the demand for funds today.
Real interest rate rises.
Savings and quantity of funds supplied increases.

Question 30

If one of the influences on saving plans changes and saving increases….

Answer 30

The supply of funds increases.

Real interest rate falls, investment increases.

Question 31

Government in the Loanable Funds Market.

Government budget surplus and deficit

Answer 31

Government enters the financial loanable market when it has a budget surplus or deficit.

• Government budget surplus increases the supply of funds.
• Government budget deficit increases the demand for funds.

Question 32

Government budget surplus increases the supply of funds.

Answer 32

Real interest rate falls, investment increases, savings decreases.

Question 33

Government budget deficit increases…

Answer 33

the demand for funds. The real interest rate rises, saving increases, investment decreases.

Question 34

Ricardo Barro Effect:

Answer 34

Budget deficit increases the demand for funds.
Rational taxpayers increase saving, which increases the supply of funds. Crowding out is avoided. Increased saving finances the deficit.