financial systems and circular income

Question 1

what is a financial system?

Answer 1

A financial system is a system of financial markets and intermediaries through which borrowers acquire funds from savers

Question 2

what are they key services of the financial system?

Answer 2

1) risk sharing
2) liquidity
3) information

Question 3

what is investment?

Answer 3

investment is the purchase of new capital goods

Question 4

What is the rule in a closed economy?

Answer 4

S = I
value of dollars saved = value of investment
there are no net exports

Question 5

what is the loanable funds market?

Answer 5

a way in which households make their saved money available to borrowers

Question 6

what is the supply of funds?

Answer 6

sum of household savings + govt budget surplus

govt surplus = net taxes > govt purchases

Question 7

what is the demand of funds?

Answer 7

planned investment spending of business + consumer loans + govt sector’s budget deficit

budget deficit = govt purchases > net taxes

Question 8

What happens when the real interest rate is high?

Answer 8

opportunity cost of consumption is higher so savings increase.
Movement

Question 9

what are the factors that shift the aggregate savings curve?

Answer 9

1) household income
2) household wealth
3) household’s expected income
4) saver preference for saving

Question 10

what are the determinants of saving preferences?

Answer 10

1) smoothing consumption - save more while working. Spend in retirement
2) market and psychological factors
3) person’s patience

Question 11

what is the relationship between interest rates and investment?

Answer 11

Higher interest rate ,lower wty of funds demanded. Movement down

As people would rather save

Question 12

factors affecting investment? (causes shifts)

Answer 12

1) expected profit rate - increase if high expected profit rate
2) taxes - higher taxes cause decrease

Question 13

what are the different demand curves that are a part of the total demand for funds curve?

Answer 13

1) govt demand
2) investment demand (firms)
3) consumer borrowing

Question 14

what are leakages?

Answer 14

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

Question 15

what are injections?

Answer 15

spending from sources other than households
1) planned investment
2) govt purchases

Question 16

what us crowding out?

Answer 16

decline in one sector’s spending caused by an increase in some other’s sector’s spending
leakages = injections

Question 17

what are the functions of a bank?

Answer 17

1) pool savings - taking money deposits from public
2) reduce risk
3) spread risk
4) coordinate lenders and borrowers
5) minimize information costs

Question 18

what is the risk associated with a bond?

Answer 18

issuer will not make the pyments as they are stated on the bond
higher the risk, higher interest rate

Question 19

what is the market price of bonds?

Answer 19

the market price = present value
FV / 1+ r

Question 20

what is the relationship between market price and market interest rate?

Answer 20

inverse relatiuonship
when the market price increases, the interest rate decreases and vice versa

Question 21

why are we sure the equally risk bonds will all move to one price?

Answer 21

buying and selling will equalize the rate of return. investors compare the rates of return on alternative assets

Question 22

what is a function of stock markets?

Answer 22

THEY ENCOURAGE INVESTMENT AND GROWTH

Question 23

what are the causes of intermediation (banks, stock markets, bond markets) failure?

Answer 23

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