Chapter 9- Savings, Investment, and Finances

Question 1

Savings

Answer 1

income not spent on consumption goods

Question 2

investment

Answer 2

purchase of new capital goods

Question 3

Supply of Savings- 4 Factors
#1- Smoothing Consumption

Answer 3

consumption is less during work years(less than income), higher than income after retirement
smoothes consumption- reason to save
LIFECYCLE THEORY

Question 4

2-Individuals are important

Answer 4

time preference- desire to have goods and services sooner rather than later(impatience)
impatient person ignores long term advantages

Question 5

3- Psychological Factors

Answer 5

way choices are presented makes difference

Question 6

4- Interest Rate

Answer 6

interest rates are reward for saving

higher interest rate= more that will be in savings

Question 7

Reasons for Borrowing #1- Individuals want to smooth consumption

Answer 7

borrow to smooth consumption
borrow to get ahead
lifecycle theory of savings- income starts out low, rises and peaks during peak working years(saving), falls during retirement(dissaving)
borrowing, saving, and dissaving smooth consumption path

Question 8

Borrowing #2- necessary for large investments

Answer 8

new businesses need investments to start(borrow money)
established businesses borrow to finance large projects
ability to borrow increases ability to invest, which increases standard of living and economic growth

Question 9

Borrowing #3- Interest Rate

Answer 9

how much businesses take out depends on interest rate
will only take loan if they will be able to pay plus profit
lower interest rate. the more will want to be taken
repayment time, amount of loan, type of collateral, and risk for default affect interest rate

Question 10

Equilibrium for Loanable Funds

Answer 10

market for loanable funds- when suppliers(savers) trade with demanders(borrowers)
equilibrium- quantity demanded equals quantity supplied
increase in supply of savings increases savings and reduces interest rate- savings goes to investment(growth)
decrease in investment demand decreases savings and interest rate
gov typically offers investment tax credit to spur investment

Question 11

Role of Intermediaries- Banks

Answer 11

evaluate ability of people to pay off loan, minimize information costs
pays interest and loan funds to borrowers

Question 12

Roles- Bonds

Answer 12

bonds- IOU that documents who owes how much and when payment is to be made
for businesses
lender- one who buys bond
borrower- one who issues bond
collateral- something of value that becomes property of lender if borrower defaults
bond is type of saving that replaces investment
crowding out- decrease in private consumption and investment as a result of increase in bonds(government)
arbitrage- buying and selling of equally risky assets ensures that equally risky assets earn equal returns
interest rates and bonds move in opposite directions

Question 13

Roles- Stock Market

Answer 13

stocks- shares of ownership in a corporation
IPO- first time corporation sells stocks
simply owning stocks doesn’t add to net investment
new stocks do(need it for investment)

Question 14

Failure of Intermediates

Answer 14

reduces supply of savings
raises cost of intermediation
reduces effectiveness of lending

Question 15

Why Failure #1- Property Rights

Answer 15

gov freezes bank accounts

contracts broken- reluctant to invest

Question 16

Why Failure #2- Controls on Interest Rates

Answer 16

usuary laws- maximum ceiling on interest rate

artificially low interest rates- shortage of credit, those can’t borrow at controlled interest rate, reduces savings

Question 17

Why Failure #4- Panics

Answer 17

systemic problems

Question 18

Shadow Banking

Answer 18

includes investment banks, hedge funds, money market funds

act like banks but are less regulated and monitored than banks

Question 19

What Happened in 2007-2008

Answer 19

banks gave out mortgages with very little money down

banks borrowed so much, it was nearly more than they made