Chapter 8

Question 1

Define financial system

Answer 1

The group of institutions in the economy that help to match one person’s saving with another person’s investment.

Question 2

What are the components of the financial system

Answer 2

Financial markets (e.g., bond markets, stock markets) and financial intermediaries (e.g., banks, mutual funds).

Question 3

What makes up financial markets

Answer 3

1. bond market
2. stock market

Question 4

define bond market

Answer 4

Facilitates the borrowing of funds by selling bonds (debt finance).

Question 5

define stock market

Answer 5

Allows firms to raise funds by issuing stocks (equity finance).

Question 6

What are the financial intermediatires

Answer 6

1. banks
2. mutual funds

Question 7

Why are banks financial intermediaries

Answer 7

they accept deposits and make loans

Question 8

why are mutual funds intermediaries

Answer 8

Institutions that sell shares to the public and use the proceeds to buy a portfolio of stocks and bonds.

Question 9

Provide the 4 saving and investments

Answer 9

1. Private saving
2. Public saving
3. national saving
4. investment

Question 10

define private saving

Answer 10

The income that households have left after paying for taxes and consumption.

Question 11

define public saving

Answer 11

The tax revenue that the government has left after paying for its spending.

Question 12

define national saving

Answer 12

The sum of private saving and public saving, representing the total income in the economy that remains after paying for consumption and government purchases.

Question 13

define investment

Answer 13

The purchase of new capital, such as equipment or buildings.

Question 14

Define market for loanable funds

Answer 14

A conceptual market where savers supply funds and borrowers demand funds.

Question 15

How does interest rate fit into market for loanable funds

Answer 15

Interest Rate: The price of borrowing in the loanable funds market, determined by the supply and demand for loanable funds.

Question 16

What are the determinants of saving and investment

Answer 16

1. interest rates
2. government policies
3. Budget deficits and surpluses

Question 17

Define interest rates as a determinant of saving and investment

Answer 17

Higher interest rates provide more incentive for saving (supply of loanable funds).

Lower interest rates make borrowing cheaper, encouraging investment (demand for loanable funds).

Question 18

Define government policies as it relates to saving and investment

Answer 18

Taxes on interest income can affect the incentive to save.

Investment tax credits can encourage firms to invest.

Question 19

Define budget deficits relates to saving and investment

Answer 19

A government budget deficit reduces national saving and the supply of loanable funds, leading to higher interest rates and lower investment.

Question 20

Define budget surplus and how it relates to saving and investment

Answer 20

A government budget surplus increases national saving and the supply of loanable funds, leading to lower interest rates and higher investment.

Question 21

What is crowding out and provide an example

Answer 21

Definition: When government borrowing reduces the amount of funds available for private investment.

Example: Increased government spending financed by borrowing can lead to higher interest rates, which can discourage private investment.

Question 22

What is the supply curve

Answer 22

Represents the amount of saving at different interest rates.

Question 23

What is the demand curve

Answer 23

Represents the amount of borrowing for investment at different interest rates.

Question 24

What is equilibrium

Answer 24

Where the supply and demand curves intersect, determining the equilibrium interest rate and quantity of loanable funds.

Question 25

Provide two examples of policy impact

Answer 25

Example: A tax incentive for saving shifts the supply curve to the right, lowering interest rates and increasing the quantity of loanable funds.

Example: An investment tax credit shifts the demand curve to the right, raising interest rates and increasing the quantity of loanable funds.