financial systems and circular income Flashcards
what is a financial system?
A financial system is a system of financial markets and intermediaries through which borrowers acquire funds from savers
what are they key services of the financial system?
1) risk sharing
2) liquidity
3) information
what is investment?
investment is the purchase of new capital goods
What is the rule in a closed economy?
S = I
value of dollars saved = value of investment
there are no net exports
what is the loanable funds market?
a way in which households make their saved money available to borrowers
what is the supply of funds?
sum of household savings + govt budget surplus
govt surplus = net taxes > govt purchases
what is the demand of funds?
planned investment spending of business + consumer loans + govt sector’s budget deficit
budget deficit = govt purchases > net taxes
What happens when the real interest rate is high?
opportunity cost of consumption is higher so savings increase.
Movement
what are the factors that shift the aggregate savings curve?
1) household income
2) household wealth
3) household’s expected income
4) saver preference for saving
what are the determinants of saving preferences?
1) smoothing consumption - save more while working. Spend in retirement
2) market and psychological factors
3) person’s patience
what is the relationship between interest rates and investment?
Higher interest rate ,lower wty of funds demanded. Movement down
As people would rather save
factors affecting investment? (causes shifts)
1) expected profit rate - increase if high expected profit rate
2) taxes - higher taxes cause decrease
what are the different demand curves that are a part of the total demand for funds curve?
1) govt demand
2) investment demand (firms)
3) consumer borrowing
what are leakages?
earned income that is not spent by households during a given year.
1) net raxes = total taxes - transfers
2) hosuehold savings - portion of after-tax income that is not spent on consumption
what are injections?
spending from sources other than households
1) planned investment
2) govt purchases
what us crowding out?
decline in one sector’s spending caused by an increase in some other’s sector’s spending
leakages = injections
what are the functions of a bank?
1) pool savings - taking money deposits from public
2) reduce risk
3) spread risk
4) coordinate lenders and borrowers
5) minimize information costs
what is the risk associated with a bond?
issuer will not make the pyments as they are stated on the bond
higher the risk, higher interest rate
what is the market price of bonds?
the market price = present value
FV / 1+ r
what is the relationship between market price and market interest rate?
inverse relatiuonship
when the market price increases, the interest rate decreases and vice versa
why are we sure the equally risk bonds will all move to one price?
buying and selling will equalize the rate of return. investors compare the rates of return on alternative assets
what is a function of stock markets?
THEY ENCOURAGE INVESTMENT AND GROWTH
what are the causes of intermediation (banks, stock markets, bond markets) failure?
1) insecure propoerty rights
2) controls on interest rates and inflation - ceilings on interest rates lead to less savings and investment
3) bank failures and panics
4) politicized lending and govt owned banks- more govt owned banks, slower growth in GDP per capita and productivity growth
