Unit 4

Question 1

If the stock market crashed does it affect the economy??

Answer 1

No a crash in the stock market will only have effects on people who chose to invest in the market. Not the whole economy.

Question 2

Income

Answer 2

A flow of compensation per unit of time
- always has a time attached to it to give it meaning

Question 3

Saving

Answer 3

The amount of income not spent
- no time needed to be attached to

Question 4

Wealth

Answer 4

A stock variable at a given point in time.
Equal to financial assets minus financial liabilities.

Question 5

MONEY

Answer 5

A stock variable equal to financial assets
used for transactions.

Question 6

Investment

Answer 6

The purchase of new capital goods

Question 7

Difference between psysical capital and a financial investment

Answer 7

Physical capital= tangible items
Financial investment = stock (change of owners)

Question 8

What is the source of funds for investments

Answer 8

Saving

Question 9

3 types of financial markets

Answer 9

• loan markets
• Bond markets (lend or borrow to purchase a bond - can sell your share on a. Secondary market before you maturity date)
• stock markets

-> these are all examples of markets for loanable funds

Question 10

Financial institutions

Answer 10

is a firm that operates on both
sides of the markets for financial capital.
It is a borrower in one market and a lender in another.

Question 11

Key financial institutions are:

Answer 11

 Investment banks
 Commercial banks
 Government-sponsored mortgage lenders
Pension funds
Insurance companies

Question 12

Net Worth - solvent and insolvent

Answer 12

A financial institution’s net worth is the total market value of what it has lent minus the market value of what it has borrowed.

• If net worth is positive, the institution is solvent and can remain in business.
• But if net worth is negative, the institution is insolvent and
  go out of business.

Question 13

What to do if your net worth is negative and institutions is insolvent

Answer 13

Your company should get out of business BUT government can help them out: they use tax $$ to helped ue to these business es being deeply rooted into the market

Question 14

Funds that finance investments

Answer 14

1. Household saving
2. Government budget surplus
3. Borrowing from the rest of the world

Question 15

The market for loanable funds

Answer 15

is the market in which households, firms, governments, and financial institutions
borrow and lend.

Question 16

The quantity of loanable funds demanded depends on

Answer 16

1. The real interest rate (-) - want low interest rate
2. Expected profit (+) - high profit
3. Disposable incomes (+)
4. Expected future income (-)
5. Wealth (-) -> less saving today bcs you already feel wealthy
6. Default risks (-)

Question 17

Effects of changes on the demand curve of loanable funds

Answer 17

Change in r: moving along the curve
- a RISE in the real interest rate decreases investment and the quantity of loanable funds demanded
- a FALL in the real interest rate increases investment and the quantity of loanable funds demanded

Change in expected profit: shifting the curve

Question 18

What does a rise or fall in real interest rate effect

Answer 18

• a rise in the real interest rate increases saving and the quantity of loanable funds
• a fall in the real interest rate decreasing saving and the quantity of loanable fund supplied

Question 19

Equilibrium in the loanable funds markets

Answer 19

the real interest rate at which the quantity of loanable
funds demanded equals the quantity of loanable funds
supplied.

Question 20

Surplus, shortage and equilibrium in funds

Answer 20

Surplus: the real interest rate falls
Shortage: real interest rate rises
Equilibrium

Question 21

Financial market volatility

Answer 21

Changes in demand or supply in the market for loanable
funds cause volatility in the financial market.
Volatility will lead to fluctuations in
• r
• the quantity of loans
• asset prices

Question 22

What happens when there is an increase in demand for loanable funds

Answer 22

It will raise the real interest rate and increase saving

Question 23

What happens when there is an increase of the supply of loanable funds

Answer 23

It lowers the real interest rate and increases investment

Question 24

The effect of a government budget surplus

Answer 24

Supply of funds increases.
The real interest rate falls.
Investment increases.

Question 25

The effect of a government budget deficit

Answer 25

demand for funds
increases.
The real interest rate rises.
Investment decreases
(crowding-out effect)

• increase rate is not necessarily goof for market: will cost more to borrow causing a decrease in investments

Question 26

The Ricardo-Barro effect

Answer 26

A budget deficit increases
the demand for funds.
Rational taxpayers increase
saving, which increases the
supply of funds.
Crowding-out is avoided.
Increased saving finances
the deficit.

Question 27

International borrowing and lending

Answer 27

A country’s loanable funds market connects with the
global market through net exports (NX = X-M).

If NX<0 (X<M), the country is a borrower. - trade deficit: other countries are investing in us

If NX>0 (X>M), the country is a lender - we are sending capital to other countries