Chp23 - Finance, Saving, and Investment

Question 1

Finance

Answer 1

• the activity of producing the funds that finance expenditures on capital
• how households and firms obtain and use financial resources and how they cope with the risks that arise in this activity

Question 2

Money

Answer 2

• is what we use to pay for goods and services, factors of production, and to make financial transactions
• looks at how households and firms use it, how much of it the have, how banks create and manage it, and how its quantity influences the economy

Question 3

Physical Capital

Answer 3

• the tools, instruments, machines, buildings, and other items that have been produces in he past and that are used today to produce goods and services
• Inventories are part of physical capital
• ‘capital’ refers to physical capital

Question 4

Financial Capital

Answer 4

• the funds used by firms to purchase physical capital

Question 5

Quantity of Capital

Answer 5

• changes due to investment and depreciation

Question 6

Wealth

Answer 6

• the value of all things that people own
• increases with saving
• increases with a rise in the market value of assets (capital gains)
• decreases with a fall in market value of assets (capital losses)

Question 7

Saving

Answer 7

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

Question 8

National Wealth and Saving

Answer 8

• wealth of a nation at the end of a year equals its wealth at the start of the year plus its saving during the year
• to make real GDP grow, saving and wealth must transformed into investment and capital

Question 9

Loan Markets

Answer 9

• one of three financial capital markets
• Firms: want short-term finance to buy inventories or to extend credit to their customers
• Households: want finance to purchase big ticket items

Question 10

Bond Markets

Answer 10

• one of three financial capital markets
• Bond: a promise to make specific payments on specified dates
• a person can hold a bond until fulfilled or sell it

Question 11

Stock Market

Answer 11

• one of three financial capital markets

- Stock: a certificate of ownership and claim to a firm’s profits

Question 12

Financial Institution

Answer 12

• a firm that operates on both sides of the markets for financial capital; both a borrower and lender
• Net worth of a FI = market value of lent - market value of borrowed
• Banks: accept deposits and use the funds to buy government bonds and other securities, and make loans
• Trust/Loan Companies: provide similar services to banks
• Credit Unions: banks that are owned and controlled by their depositors and borrowers; operate within provinces
• Pension Funds: receives the pension contributions of firms and workers
• Insurance Companies: provide risk-sharing services

Question 13

Solvency/Insolvency/Illiquidity

Answer 13

• Solvency: net worth is positive
• Insolvent: net worth is negative
• Illiquid: made long-term loans with borrowed funds and is face with a sudden demand to repay more than it currently has

Question 14

Financial Assets

Answer 14

• stocks, bonds, short-term securities, and loans

- The interest rate on an asset is the interest received expressed as a percentage of the price of the asset

Question 15

Loanable Funds Market

Answer 15

• the aggregate of all the individual financial markets

Question 16

Nominal Interest Rate

Answer 16

• 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 17

Real Interest Rate

Answer 17

• the nominal interest rate adjusted to remove the effects of inflation on the buying power of money
• = nominal interest rate - inflation rate
• The opportunity cost of loanable funds
• the real interest rate paid on borrowed funds is the opportunity cost of borrowing
• the real interest rate forgone when funds are used either to buy consumption goods and services or to invest in new capital goods is the opportunity cost of not saving or not lending those funds

Question 18

Quantity of Loanable Funds Demanded

Answer 18

• total quantity of funds demanded to finance investment, the government budget deficit, and int. lending/investment during a given period
• influenced by: The real interest rate & expected profit
• Higher Real Interest Rate = decreases investment and quantity of loanable funds demanded
• High Expected future capital = higher investment & greater demand for lonable funds

Question 19

Quantity of Loanable Funds Supplied

Answer 19

• the total funds available from private saving, the government budget surplus, and international borrowing during a given period
• influenced by: the real interest rate, disposable income, expected future income, wealth, default risk
• Higher real interest rate = higher saving and lonable funds

Question 20

Disposable Income

Answer 20

• households incomes earned minus net taxes

- higher disposable income = higher saving

Question 21

Expected Future Income

Answer 21

• Higher expected future income = lower saving

Question 22

Default Risk

Answer 22

• risk that a loan will not be repaid

- greater the risk, the higher the interest rate

Question 23

Government Budget Surplus

Answer 23

• increases the supply of loanable funds
• real interest rate falls, decreases household saving, decreases quantity of private funds supplied
• low interest rate increases funds demanded and increases investment

Question 24

Government Budget Deficit

Answer 24

• increases the demand for loanable funds
• real interest rate rises, increases household saving, increases funds supplied
• higher interest rate decreases investment and funds demanded

Question 25

Crowding-Out Effect

Answer 25

• the tendency for government budget deficit to raise the real interest rate and decrease investment
• ‘crowds-out’ businesses by scooping up available financial capital

Question 26

Ricardo-Barro Effect

Answer 26

• the government budget has not effect on real interest rate or investment

Question 27

Global Loanable Funds Market

Answer 27

• funds flow into the country who’s interest rate is the highest and vice versa
• when funds leave a low interest country, interest rate increases due to a shortage of funds

Question 28

International Borrowing and Lending

Answer 28

• If a country’s net exports are negative, the rest of the world supplies funds to that country and the quantity of loanable funds is greater than national saving and vice versa
• International Borrower - funds flow in
• International Lender - funds flow out