Lecture 1 - Financial Crises: Institutions Flashcards
What is barter?
Barter is the exchange of goods and services for other goods and services
By who were the benefits of specialization perfectly understood by?
The benefits of specialization and thus barter, over self-sufficiency were perfectly understood by Adam Smith who offered the well quoted pin factory example
What is meant by self-sufficiency?
Under self-sufficiency each household eats what it gathers and hunts, wears whatever clothes it makes and lives in shelters that it builds
What are the benefits of the exchange of goods and services by encouraging specialisation?
The exchange of goods and services by encouraging specialisation boosts productivity, output and welfare
What is the main disadvantage of barter?
- The main disadvantage of barter is that it requires a double coincidence of wants, a term coined by W.S Jevons
- This means that both parties have to have what the other one wants and be willing to exchange with each other
- Barter also requires the establishment of too many prices. For example if we have n goods we could have up to n(n-1)/2 prices
Explain the solution to the problem of barter requiring the establishment of too many prices
- The solution has been to establish a generally accepted commodity as a medium of exchange that also serves as the unit of account
- As long as all parties agree to this arrangement then a seller of goods and services needs only to find someone who is willing to buy them and is in possession of the medium of exchange. Under this arrangement only n-1 prices are needed
Over time, how has the types of commodities used for exchange changed?
Over time, many types of commodities have been used as a media of exchange, eg. Shells, stones, copper, bronze, silver and gold. Later commodities were substituted by pieces of paper (fiat currency) issued by the Central Bank and more recently by electronic transfers
In ancient societies, how did the system of credit help households negatively affected by a natural disaster?
-In ancient societies, natural disasters often had disastrous effects on household’s consumption patterns
- To mitigate such effects, a system of credit was developed whereby in any given period, fortunate households would lend their surplus food to those households negatively affected by a disaster
- The expectation was that the household benefitting from this exchange would reciprocate in the future when fortunes possibly would be reversed
In ancient societies, how did they keep track of who owes whom when households helped each other out during a natural disaster?
Various systems of tallies were developed to keep accounts of who owes whom
Explain how stock markets work
- In stock markets participants trade corporate ownership shares
- The holder is entitled a proportional share of profits and losses of the issuing firm (equity contracts)
Explain how bond markets work
In bond markets firms borrow funds by promising to pay back the amount borrowed plus some interest rate charges within a pre-specified period. Such fixed obligations are known as debt contracts
Who is direct finance suitable for?
Direct finance is suitable for large and old firms that have established good reputation in the market
How are small firms and households who need to borrow funds but lack the credentials able to borrow?
Small firms and households who need to borrow funds but lack the credentials to borrow from the market might get access to funds from financial intermediaries (eg. Banks)
How do banks offer deposits and loans to different households and firms?
Banks offer deposits to those households and firms that would like to postpone spending and they offer loans to households and firms that would like to spend but do not have the funds
What does the balance sheet of a bank show?
- The balance sheet shows what bank owns (assets) and what it owes (liabilities)
- Equity is what is owed to the owners
When is a bank solvent and insolvent?
- If equity is positive then the bank is solvent
- If equity is negative then the bank is insolvent
What does the term autarky mean?
Autarky refers to an economy that is self-sufficient (closed economy)
How can the benefits of specialization be enhanced?
As David Ricardo demonstrated with his theory of comparative advantage, the benefits of specialization can be enhanced by allowing the exchange of goods and services across national borders (international trade)
What is the mechanism when currencies are freely traded?
When currencies are freely traded, the mechanism is the market
