Chapter 8 - Savings, Investements, Financial System Flashcards
What’s the relation between productivity and GDP
We increase GDP by increasing productivity, which increases quality of life. We increase productivity with human capital, physical capital, natural resources, and human knowledge
What is the financial system
The group of institutions in the economy that help to match one person’s savings with another person’s investment. So savings = investment
Why are saving and investment key ingredients to long-run economic growth
Because investment can only happen if someone else saved it. When a country saves a lot of its GDP, more money is available for investment in capital, and higher capital raises productivity
2 categories of financial institutions
- Financial markets
- Financial intermediaries
Financial markets
What are financial markets
Financial institutions through which savers can directly provide funds to borrowers
Financial Markets
What is a bond, and an example
Basically an IOU, a promise that the borrower will pay back the money to the holder of the bond, plus interest, but they don’t own any of the property, so if they make millions you don’t’t make more, and if they go down they still need to pay you
Ex: borrow $1000 for a year, then after a year you pay back the principal and interest
Financial Markets
What is stock
Represents ownership in a firm and is, therefore, a claim to its profits; if they make more, you make more.
Financial Intermediaries
What is it and a main one
- financial institutions where savers can indirectly provide funds to borrowers
- Banks ; their primary function is to take deposits from savers and use them to make loans to people who want to borrow
Financial Intermediaries
What are mutual funds
An institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds
GDP equation with some important identities
GDP can now be stated at Y which is income
GDP (or Y) = C(consumption) + I(Investment) + G(government spending) + NX (net exports)
For a closed economy, no NX so Y= C + I + G
National savings, it’s equation and what it equals
The total income in the economy that remains after paying for consumption and government purchases.
S = Y - C - G, which if we rearrange the GDP equation, that equals I
Which means Savings = Investment
What determines investment
Investment is determined by available savings in the economy. If there’s an increase in savings, banks can lend more to finance investment projects. So savings=investment
2 ways national savings can be expressed
Let T denote the taxes collected by govt minus transfer payments
S= Y - C - G (both private and public savings)
S= (Y - T - C) + (T - G) (separates private and public savings
Private savings vs public savings
Private savings - income that households have left after paying for taxes and consumption Y-T-C
Public savings - the tax revenue that the govt has left after paying for its spending T-G
When does a budget deficit and surplus occur
Deficit when T<G>G</G>
What is the market for loanable funds
The market in which those who want to save supply funds and those who want to borrow to invest demand funds
What is the demand, supply, and price in this market
Savings is the source of supply for loanable funds
Investment is the source of demand for loanable funds
The interest rate is the price of a loan
Demand/supply curves all the same
Policy as saving incentives
Higher saving rate can lead to higher rate of growth of GDP
Shifts supply curve
Policy as investment incentives
Investment tax credit gives a tax advantage to any firm building a new factory of buying new equipment, will shift demand curve
Policy - government deficits and surpluses
Government debt - the sum of last budget deficits and surpluses
Crowding out - a decrease in investment that results from govt borrowing
Vicious circle vs virtuous circle
Vicious (bad cycle) - big deficits, less money available to borrow, higher interest rates, less business investment , slower economy, less tax money and more govt spending, even bigger deficit
Virtuous (good cycle) - big surpluses, more money available to borrow, lower interest rates, more business investment, faster economy, more tax money and less govt spending, even bigger surpluses
Affects supply curve
