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Macroeconomics > Week 5 > Flashcards

Week 5 Flashcards

1
Q

Types of financial institutions

A

Financial markets

Financial intermediaries

Other

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2
Q

Financial markets

A

institutions through which savers can directly provide funds to borrowers

Bond market

Stock market (ASX)

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3
Q

Financial intermediaries

A

institutions through which savers can indirectly provide funds to borrowers

Banks
Managed funds

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4
Q

Other

A

Credit unions
Pension (superannuation) funds
Insurance companies

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5
Q

Financial markets: the bond market

A

A bond is a certificate of indebtedness (IOU) that specifies obligations of the borrower to the holder of the bond

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6
Q

Characteristics of a bond

A

Term

Credit risk

Tax treatment

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7
Q

Bond term

A

The length of time until maturity.

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8
Q

Bond credit risk

A

The probability that the borrower will fail to pay some of the interest or principal.

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9
Q

Bond tax treatment

A

The way in which the tax laws treat the interest on the bond.
In Australia interest earned on bonds is taxed as any other form of income. In the U.S. municipal bonds are federal tax exempt.

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10
Q

Financial markets: the stock market

A

A share is a claim to partial ownership in a firm.

The sale of stock to raise money is called equity financing.

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11
Q

What is the most important stock exchange in Australia?

A

the Australian Stock Exchange (ASX).

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12
Q

What information do most newspaper stock tables provide?

A

Price (of a share)

Volume (number of shares sold)

Dividend (profits paid to stockholders)

Price-earnings ratio

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13
Q

Financial intermediaries: indirect borrowing

Banks

A

take deposits from people who want to save and use the deposits to make loans to people who want to borrow.
pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans

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14
Q

Financial intermediaries

A

Banks help create a medium of exchange by allowing people to write cheques against their deposits or use credit cards
A medium of exchange is an item that people can easily use to engage in transactions.
This facilitates the purchases of goods and services.

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15
Q

What do managed funds allow

A

They allow people with small amounts of money to easily diversify their portfolio

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16
Q

Recall the GDP formula

A

Recall that GDP is both total income in an economy and total expenditure on the economy’s output of goods and services:

Y = C + I + G + NX

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17
Q

Recall the GDP formula as a closed economy

A

Assume a closed economy – one that does not engage in international trade (imports and exports are zero):

Y = C + I + G

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18
Q

National saving or just saving (S)

A

Now, subtract C and G from both sides of the closed economy GDP equation:
Y – C – G = I

The left side of the equation is the total income in the economy after paying for consumption and government purchases.

This is referred to as National saving, or just saving (S).

Substituting S for Y - C - G, the equation can be written as:
S = I

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19
Q

Does savings equal investments

A

This equation states that savings equals investment. Is it always true?
Important macroeconomic distinction between them that differs from our common usage of the term investment
Is buying shares/bonds an investment?

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20
Q

National saving, or saving, is equal to:

A

S = I
S = Y – C – G
S = (Y – T – C) + (T – G)

21
Q

National Saving Consists of

A

Private and Public Components

22
Q

Private saving

A

Private saving is the amount of income that households have left after paying their taxes and paying for their consumption.
Private saving = (Y – T – C)

23
Q

Public saving

A

Public saving is the amount of tax revenue that the government has left after paying for its spending.
Public saving = (T – G)

24
Q

Budget Surplus and Deficit

A

If T > G, the government runs a budget surplus because it receives more money than it spends.
The surplus of T − G represents public saving.
If G > T, the government runs a budget deficit because it spends more money than it receives in tax revenue

25
Q

The market for loanable funds

A

Financial markets ‘coordinate’ the economy’s saving and investment in the market for loanable funds.
The market for loanable funds is the market in which those who want to save supply funds and those who want to borrow to invest demand funds

26
Q

Loanable funds

A

Loanable funds refer to all income that people have chosen to save and lend out, rather than use for their own consumption

27
Q

the supply of loanable funds

A

The supply of loanable funds comes from people who have extra income they want to save and lend out.

28
Q

The demand for loanable funds

A

The demand for loanable funds comes from households and firms that wish to borrow to make investments.

29
Q

Interest rate

A

The interest rate is the price of the loan.

It represents the amount that borrowers pay for loans and the amount that lenders receive on their saving.

30
Q

Interest

A

Interest represents a payment in the future for a transfer of money in the past.

31
Q

Nominal interest rate (i)

A

The nominal interest rate (i) is the interest rate usually reported and not corrected for inflation.
It is the interest rate that a bank pays or asks for

32
Q

Real interest rate (r)

A

The real interest rate (r) is the nominal interest rate that is corrected for the effects of inflation: r = i – inflation

33
Q

Supply and demand for loanable funds

A

Financial markets work much like other markets in the economy.
The equilibrium of the supply and demand for loanable funds determines the real interest rate.

34
Q

The market for loanable funds graph

A

Photo in favourites 17/8/18

35
Q

What government policies can affect saving and investment?

A

taxes on saving
taxes on investment
government budgets

36
Q

Pros and cons of government budget deficits

A

Pros:
Stimulates the economy when in recession

Cons:
Accumulation of government debt

Crowding out effect

37
Q

The effect of a government budget deficit

A
  1. A budget deficit decreases the supply of loanable funds for any interest rate
  2. Which raises the equilibrium interest rate
  3. And reduces the equilibrium quantity of loanable funds in dollars
38
Q

The effect of a government budget deficit illustrated

A

Photo in favourites 17/8/18

39
Q

What does a government budget deficit do

A

A budget deficit decreases the supply of loanable funds.

Shifts the supply curve to the left.

Increases the equilibrium interest rate.

Reduces the equilibrium quantity of loanable funds.

40
Q

The effect of a government budget deficit illustrated

Why does the movement occur

A

Movement 1: there is a move of the whole S curve to the left (by $700), i.e. from A to B
As a consequence, there is shortage of saving and this bids up the interest rate up
BECAUSE of that increase in r, there are two additional movements, ALONG the S and D curves

41
Q

Crowding out effect (occurs during government budget deficits)

A

One implication of this model is that government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households and firms. This fall in investment is referred to as crowding out.
The deficit borrowing crowds out private borrowers who are trying to finance investments

42
Q

What does a decrease in the tax rate on savings do to households’ incentive to save (at any given interest rate)?

A

The supply of loanable funds curve shifts to the right.

The equilibrium interest rate decreases.

The quantity demanded for loanable funds increases.

43
Q

What does a decrease in the tax rate on savings do to households’ incentive to save (at any given interest rate)? illustrated

A

Photo in favourites 17/8/18

44
Q

What does an increase in the investment tax credit (i.e. a decrease in the effective corporate tax rate) do to firms’ incentive to borrow (at any given interest rate)?

A

Increases the demand for loanable funds.

Shifts the demand curve to the right.

Results in a higher interest rate and a greater quantity saved.

45
Q

What does an increase in the investment tax credit (i.e. a decrease in the effective corporate tax rate) do to firms’ incentive to borrow (at any given interest rate)?
ILLUSTRATED

A

Photo in favourites 17/8/18

46
Q
  1. The demand for loanable funds is downward-sloping because:
    a. as the interest rate falls, the demand for loanable funds increases
    b. as the interest rate falls, the demand for loanable funds falls
    c. as the interest rate rises, the quantity of loanable funds demanded rises
    d. as the interest rate rises, the quantity of loanable funds demanded falls
A

ANS: D The demand for loanable funds comes from businesses’ willingness and ability to invest in business productive capital and ventures. As the cost of investing (the real interest rate) increases, the potential profitability of investments decreases. Thus, as the real interest rate rises, businesses are less willing and less able to proceed with investment plans, consequently the overall quantity demanded of loanable funds (for business investment) declines.

47
Q

Using a graph representing the market for loanable funds, show and explain what happens to interest rates and investment if the investment tax credit is abolished.

A

As shown in the graph below, the economy starts in equilibrium at point E0, with interest rate r0 and equilibrium quantity saved and invested at q0. If the investment tax credit is abolished, the incentive to invest is reduced, and less investment will be undertaken at each interest rate. Therefore, the demand-for-loanable-funds curve shifts from D0 to D1. The new equilibrium is at E1, with a lower interest rate, r1, and a lower level of saving and investment, q1. Hence, elimination of the investment tax credit reduces interest rates and reduces investment.

Photo in favourites 27/8/18

48
Q

Define crowding out and explain its implication on the economy.

A

Crowding out refers to the tendency for increased government deficits to reduce investment spending. Specifically, the reduction in investment stems from the fact that a decrease in public saving reduces national saving, pushing up the real interest rate in the loanable fund market.

Macroeconomics (12 decks)

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