Chapter 7 Flashcards
Financial capital
the funds that firms use to buy physical capital and that households use to buy a home or invest in human capital
Gross investment
total amount spent on new capital
net investment
change in quantity of capital
net investment equals
gross investment minus depreciation
wealth or net worth
the value of all the things people own, the market value of their assets @ a point in time
saving
the amount of income that is not paid in taxes or spent on consumption of goods and services
capital gains
increase in wealth from the market value of assets rising
3 types of financial markets
- loan markets
- bond markets
- stock markets
mortgage
a legal contract that gives ownership of a home to the lender in the event that the borrower fails to meet the agreed payment schedule
bond
a promise to make specified payments on specified dates
bond market risk
safe and return is usually small
stock market risk
higher risk, volatile, return can be bigger
term to maturity (bond)
the length of time till the bond matures
yield curve (bond)
the relationship between the term of a bond and the interest rate
usually the longer the term the higher the interest rate so the yield curve slopes upward
stock
certificate of ownership and claim to firms profits
stock market
a financial market in which the shares of stocks of corporations are traded
financial institutions
a firm that operates on both sides of the markets for financial capital. It borrows from one market and lends to another
the 6 key Canadian financial institutions
- banks
- trust and loan companies
- credit unions and cassies populaires
- mutual funds
- pension funds
- insurance companies
financial institution net worth
the market value of what a financial institution has lent minus the market value of what it has borrowed
solvent
if the institutions net worth is postive
insolvent
if the institutions net-worth is negative
3 sources that investment finance comes from
1.) household savings
2.) gov budget surplus
3.) borrowing from the rest of the world
net taxes
taxes paid to gov minus cash transfers received from gov
income (y) =
sum of consumption expenditure, saving and net taxes
Y= C + S - T
Investment (I) =
I = Savings + (Taxes-Gov. Expenditure) + (Imports-Exports)
what is (T-G)
Government Budget Surplus
nominal interest rate
the 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
the real intrest rate
the nominal intrest rate adjusted to remove the effects of inflation on the buying power of money. It is aprox equal to the nominal intrest rate minus the inflation rate
the loanable funds market
the aggregate of all the indvidual markets in which households, firms, governments, banks and other financial institutions borrow and lend
2 factors that determine investment and the demand for loanable funds to finance it
1.) the real interest rate
2.) expected profit
the demand for loanable funds curve
the relationship between the quantity of loanable funds demanded and the real intrest rate when all other influences on borrowing plans remain the same
5 factors that influence the decision on how much of your income to save and supply the loanable funds market
1.) the real intrest rate
2.) disposable income
3.) expected future income
4.) wealth
5.) default risk
supply of loanable funds
the relationship between the quantity of loanable funds supplied and and the real intrest rate when all other influences on borrowing plans remain the same
what changes the supply of loanable funds (4)
a change in
- disposable income
- expected future income
- wealth
- default risk changes
disposable income and supply of loanable funds
when disposable income increases, other things remaining the same, consumption expenditure increases, but by less than the increase in income , some is saved. This increases the supply of loanable funds
disposable income
income earned - net taxes
expected future income and loanable funds
the higher the expected future income (other things remaining the same) the smaller the savings today, the smaller the supply of loanable funds today
Wealth and loanable funds
the higher a households wealth, other things remaining the same the smaller its saving
default risk
the risk that a loan will not be repaid
default risk and loanable funds
the greater the default risk the higher is the intrest rate needed to induce a person to lend and the smaller is the supply of loanable funds
gov budget surplus and loanable funds
- increases the supply of loanable funds
- real intrest rate falls - decreases HH saving and decreases the quantity of private funds supplied
- lower the real intrest rate, higher QD of loanable funds and higher investment
gov budget deficit and loanable funds
- increases demand for loanable funds
- real intrest rate increases - investment decreases - and QD of loanable funds to finance investment deceases
- HH saving increases and priv funds supplied increases
The crowding out effect
- the tendency for a gov budget deficit to raise the real intrest rate and decrease investment
- does not decrease investment by full amount of gov budget deficit bc higher real intrest rate induces increase in priv savings that partly contributes to financing the deficit
The Ricardo Barro Effect
- holds other effects wrong and says the gov budget has no effect on either real intrest rate or investment
- taxpayers are rational and can see that budget defcit today means future taxes will be higher and future disposable income will be lower so they save more today
- the priv supply of loanable funds increases to match the QD by the gov
