Week 5

Question 1

eName three facts about the wealth of Nations and Economic Growth

Answer 1

Fact one: GDP per Capita varies enormously among Nations
Fact two: Everyone used to be poor
Fact three: There are Growth Miracles and Growth Disasters

Question 2

Explain Economic growth

Answer 2

By economic growth, we mean the growth rate of real GDP per capita.

Question 3

Whats the rule of 70

Answer 3

The rule of 70 is a mathematical approximation.

If you only have 1% of growth every year, but year after year, it will take you 70 years to double your GDP

Question 4

Define Physical capital

Answer 4

Economists refer to physical capital as tools in the broadest sense of the word: pencils, desks, computers, hammers, shovels, etc.

Question 5

Define human capital

Answer 5

By human capital economists mean the tools in the mind, or the stuff in people’s heads that makes them productive

Question 6

What are the factors of production

Answer 6

Physical capital
Human capital
Technical knowledge

Organisation (org ties it all together)

Question 7

How come some countries have more physical and human capital than others?

Answer 7

Because poor countries like North Korea not only have less physical and human capital than rich countries, but they also fail to organize the capital that they do have in the most productive ways

Question 8

What are the most important insititutions?

Answer 8

• Property rights
• Honest governments
• Political stability
• A dependable legal system
• Competitive and Open Markets

Question 9

Define Saving

Answer 9

Saving is income that is not spent on consumption goods

Question 10

Define Investment

Answer 10

Investment is the purchase of new capital, things like tools, machinery, and factories

Question 11

What are the four major factors when it comes to the supply of savings?

Answer 11

• Smoothing consumption
• impatience
• marketing and psychological factors
• and interest rates

Question 12

What is time preference?

Answer 12

Time preference reflects the fact that today feels more real than tomorrow.

Question 13

Explain the market for loanable funds

Answer 13

Supply of savings and the demand to borrow put together

Question 14

Whats an investment tax credit?

Answer 14

An investment tax credit gives firms that invest in plants and equipment a tax break

Question 15

How is an equilibrium achieved in the markets for lendable funds?

Answer 15

Equilibrium is brought about with the assistance of financial intermediaries, such as banks, bond markets, and stock markets.

Question 16

Define a financial intermediary

Answer 16

A financial intermediary is an institution that helps to bring about the equilibriul and to direct resources to more highly valued uses

Question 17

Define a bond

Answer 17

When a member of the public lends money to a corporation, the corporation acknowledges its debt by issuing a bond.

Question 18

Whats an advantage of a bond?

Answer 18

One of the advantages of bond finance is that large sums of money can be raised now and invested in long-lived assets such as railroad tracks.

Question 19

What are default risks?

Answer 19

All bonds carry the risk that the borrower will no longer be able to pay when the payments become due.

Question 20

What is collateral?

Answer 20

Something of value that by agreement becomes the property of the lender if the borrower defaults (for example a house)

Question 21

Explain the term “crowded out”

Answer 21

Crowding out is the decrease in private consumption and investments that occurs when the government borrows more.

Question 22

Give the formula for ‘rate of return for a zero coupon bond’

Answer 22

((Face value - price) / Price) x100

Question 23

Interest rates and bond prices move in _______ directions.

Answer 23

opposite

Question 24

Define stocks

Answer 24

Stocks are shares of ownership in a corporation.

Question 25

Define an IPO

Answer 25

An IPO is the first time a stock is sold to the public

Question 26

What happens when intermediation fails?

Answer 26

There is no economic growth without savings, and those savings have to be processed and mediated through banks, bond markets, stock exchanges, etc. Countries without these institutions have smaller markets for loans, use their savings less effectively, and make fewer good investments.

Question 27

How can the bridge that connects savers and borrowers be broken?

Answer 27

• unsafe property rights
• Inflation and interest rate control
• politicized loans
• massive bank failures
• panics

These problems break the bridge by
1. Reducing the supply of savings
2. Raising the cost of intermediation
3. Reducing the effectiveness of lending

Question 28

What are “usury laws”

Answer 28

laws that specify the maximum legal interest rate at which loans can be made

Question 29

explain the leverage ratio

Answer 29

In the financial world, the debt/equity ratio is called the leverage ratio

Question 30

What is securitization?

Answer 30

The seller of a securitized asset receives cash in advance, while the buter is entitled to a flow of future payments

Question 31

Why might banks wish to sell or “securitize” their loans?

Answer 31

+ Bank gets more liquid cash
+ makes its balance sheet safer
+ Securitized assets can be help as investments by institutions with a long-term perspective

Question 32

Whats the difference between investment banks and commercial banks?

Answer 32

In a commercial bank, the money comes from depositors. In an Investment bank, the money comes from investors. Deposits are government-guaranteed but investments are not, so investors are more prone to panic and withdraw their short-term funding in times of crisis

Question 33

In Investment banking, what’s a fire sale?

Answer 33

Without the short-term loans, the investment bank no longer has enough operating funds and it is forced to sell off assets quickly in what is often called a “fire sale.”

Question 34

In Investment banking, what’s a firestorm?

Answer 34

Now the bank has to sell its assets, which decreases the value of other financial assets which brings other banks into trouble, they have to sell their assets and so on and on. This is called a firestorm.

Question 35

Define Gross Domestic Product

Answer 35

The market value of all final goods and services produced within a country in a year

Question 36

What does GDP measure?

Answer 36

• Production
• Final goods and services
• Final physical capital
• Goods produced locally in the country