Chapter 7

Question 1

Financial capital

Answer 1

the funds that firms use to buy physical capital and that households use to buy a home or invest in human capital

Question 2

Gross investment

Answer 2

total amount spent on new capital

Question 3

net investment

Answer 3

change in quantity of capital

Question 4

net investment equals

Answer 4

gross investment minus depreciation

Question 5

wealth or net worth

Answer 5

the value of all the things people own, the market value of their assets @ a point in time

Question 6

saving

Answer 6

the amount of income that is not paid in taxes or spent on consumption of goods and services

Question 7

capital gains

Answer 7

increase in wealth from the market value of assets rising

Question 8

3 types of financial markets

Answer 8

• loan markets
• bond markets
• stock markets

Question 9

mortgage

Answer 9

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

Question 10

bond

Answer 10

a promise to make specified payments on specified dates

Question 11

bond market risk

Answer 11

safe and return is usually small

Question 12

stock market risk

Answer 12

higher risk, volatile, return can be bigger

Question 13

term to maturity (bond)

Answer 13

the length of time till the bond matures

Question 14

yield curve (bond)

Answer 14

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

Question 15

stock

Answer 15

certificate of ownership and claim to firms profits

Question 16

stock market

Answer 16

a financial market in which the shares of stocks of corporations are traded

Question 17

financial institutions

Answer 17

a firm that operates on both sides of the markets for financial capital. It borrows from one market and lends to another

Question 18

the 6 key Canadian financial institutions

Answer 18

• banks
• trust and loan companies
• credit unions and cassies populaires
• mutual funds
• pension funds
• insurance companies

Question 19

financial institution net worth

Answer 19

the market value of what a financial institution has lent minus the market value of what it has borrowed

Question 20

solvent

Answer 20

if the institutions net worth is postive

Question 21

insolvent

Answer 21

if the institutions net-worth is negative

Question 22

3 sources that investment finance comes from

Answer 22

1.) household savings
2.) gov budget surplus
3.) borrowing from the rest of the world

Question 23

net taxes

Answer 23

taxes paid to gov minus cash transfers received from gov

Question 24

income (y) =

Answer 24

sum of consumption expenditure, saving and net taxes
Y= C + S - T

Question 25

Investment (I) =

Answer 25

I = Savings + (Taxes-Gov. Expenditure) + (Imports-Exports)

Question 26

what is (T-G)

Answer 26

Government Budget Surplus

Question 27

nominal interest rate

Answer 27

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

Question 28

the real intrest rate

Answer 28

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

Question 29

the loanable funds market

Answer 29

the aggregate of all the indvidual markets in which households, firms, governments, banks and other financial institutions borrow and lend

Question 30

2 factors that determine investment and the demand for loanable funds to finance it

Answer 30

1.) the real interest rate 2.) expected profit

Question 31

the demand for loanable funds curve

Answer 31

the relationship between the quantity of loanable funds demanded and the real intrest rate when all other influences on borrowing plans remain the same

Question 32

5 factors that influence the decision on how much of your income to save and supply the loanable funds market

Answer 32

1.) the real intrest rate 2.) disposable income 3.) expected future income 4.) wealth 5.) default risk

Question 33

supply of loanable funds

Answer 33

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

Question 34

what changes the supply of loanable funds (4)

Answer 34

a change in - disposable income - expected future income - wealth - default risk changes

Question 35

disposable income and supply of loanable funds

Answer 35

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

Question 36

disposable income

Answer 36

income earned - net taxes

Question 37

expected future income and loanable funds

Answer 37

the higher the expected future income (other things remaining the same) the smaller the savings today, the smaller the supply of loanable funds today

Question 38

Wealth and loanable funds

Answer 38

the higher a households wealth, other things remaining the same the smaller its saving

Question 39

default risk

Answer 39

the risk that a loan will not be repaid

Question 40

default risk and loanable funds

Answer 40

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

Question 41

gov budget surplus and loanable funds

Answer 41

- 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

Question 42

gov budget deficit and loanable funds

Answer 42

- 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

Question 43

The crowding out effect

Answer 43

- 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

Question 44

The Ricardo Barro Effect

Answer 44

- 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