AMBA MACROECONOMICS LECTURER: JACK WU Financial System.
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Transcript of AMBA MACROECONOMICS LECTURER: JACK WU Financial System.
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AMBA MACROECONOMICSLECTURER: JACK WU
Financial System
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Saving and Investment
To a macroeconomist, saving occurs when a person’s income exceeds his consumption, while investment occurs when a person or firm purchases new capital, such as a house or business equipment.
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Examples
Your family takes out a mortgage and buys a new house.
You use your $200 paycheck to buy stock in BenQ.
Your roommate earns $100 and deposits it in her account at a bank.
You borrow $1,000 from a bank to buy a car to use in your pizza delivery business.
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Financial System
The financial systemfinancial system consists of the group of financial institutions in the economy that help to match one person’s saving with another person’s investment.
It moves the economy’s scarce resources from savers to borrowers.
Financial institutions can be grouped into two different categories: financial markets and financial intermediaries.
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Financial Institutions
Financial markets are the institutions through which savers can directly provide funds to borrowers.
Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers.
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Financial Institutions: continued
Financial Markets Stock Market Bond Market
Financial Intermediaries Banks Mutual Funds
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Others
Other Financial Institutions Pension funds Insurance companies Loan sharks
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Recall GDP formula
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 + NXY = C + I + G + NX
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Important identities
Assume a closed economyclosed economy – one that does not engage in international trade:
Y = C + I + GY = C + I + GNow, subtract C and G from both sides of the
equation:Y Y –– C C –– G =I G =I
The left side of the equation is the total income in the economy after paying for consumption and government purchases and is called national saving, or just saving (S).
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Important identities: continued
Substituting S for Y - C - G, the equation can be written as:
S = IS = INational saving, or saving, is equal to:
S = IS = I
S = Y S = Y –– C C –– G G
S = (Y S = (Y –– T T –– C) + (T C) + (T –– G) G)
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Meaning of Saving
National Saving National saving is the total income in the
economy that remains after paying for consumption and government purchases.
Private Saving Private saving is the amount of income that
households have left after paying their taxes and paying for their consumption.
Private saving = (Y Private saving = (Y –– T T –– C) C)
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Meaning of Saving: Continued
Public Saving Public saving is the amount of tax revenue that the
government has left after paying for its spending.
Public saving = (T Public saving = (T –– G) G)
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Budget
Surplus and Deficit 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.
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Saving = Investment?
For the economy as a whole, saving must be equal to investment.
S = IS = I
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Market for Loanable Funds
Financial markets coordinate the economy’s saving and investment in the market for market for loanable funds.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.
Loanable fundsLoanable funds refers to all income that people have chosen to save and lend out, rather than use for their own consumption.
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Supply and Demand for Loanable Funds
The supply of loanable funds comes from people who have extra income they want to save and lend out.
The demand for loanable funds comes from households and firms that wish to borrow to make investments.
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Price of the Loan
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.
The interest rate in the market for loanable funds is the real interest rate.
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Equilibrium
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.
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Loanable Funds(in billions of dollars)
0
InterestRate Supply
Demand
5%
$1,200
Copyright©2004 South-Western
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Government Policies
Government Policies That Affect Saving and Investment Taxes and saving Taxes and investment Government budget deficits
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Saving Incentives: Tax Cut
Taxes on interest income substantially reduce the future payoff from current saving and, as a result, reduce the incentive to save.
A tax decrease increases the incentive for households to save at any given interest rate. The supply of loanable funds curve shifts to the
right. The equilibrium interest rate decreases. The quantity demanded for loanable funds
increases.
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Loanable Funds(in billions of dollars)
0
InterestRate
Supply, S1 S2
2. . . . whichreduces theequilibriuminterest rate . . .
3. . . . and raises the equilibriumquantity of loanable funds.
Demand
1. Tax incentives forsaving increase thesupply of loanablefunds . . .
5%
$1,200
4%
$1,600
Copyright©2004 South-Western
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Effects of Tax Cut
If a change in tax law encourages greater saving, the result will be lower interest rates and greater investment.
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Investment Incentives: Investment Tax Credit
An investment tax credit increases the incentive to borrow. Increases the demand for loanable funds. Shifts the demand curve to the right. Results in a higher interest rate and a greater
quantity saved.
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Loanable Funds(in billions of dollars)
0
InterestRate
1. An investmenttax creditincreases thedemand for loanable funds . . .
2. . . . whichraises theequilibriuminterest rate . . .
3. . . . and raises the equilibriumquantity of loanable funds.
Supply
Demand, D1
D2
5%
$1,200
6%
$1,400
Copyright©2004 South-Western
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Effects of Investment Incentives
If a change in tax laws encourages greater investment, the result will be higher interest rates and greater saving.
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Government Budget Deficit
When the government spends more than it receives in tax revenues, the short fall is called the budget deficit.
The accumulation of past budget deficits is called the government debt.
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Crowding Out
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.
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Budget Deficit
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.
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Loanable Funds(in billions of dollars)
0
InterestRate
3. . . . and reduces the equilibriumquantity of loanable funds.
S2
2. . . . whichraises theequilibriuminterest rate . . .
Supply, S1
Demand
$1,200
5%
$800
6% 1. A budget deficitdecreases thesupply of loanablefunds . . .
Copyright©2004 South-Western
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Effects of Budget Policies
When government reduces national saving by running a deficit, the interest rate rises and investment falls.
A budget surplus increases the supply of loanable funds, reduces the interest rate, and stimulates investment.
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Discussion
Suppose the government borrows $20 billion more next year than this year.
Use a supply-demand diagram to analyze this policy. Does the interest rate rise or fall?
What happens to investment? To private saving? To public saving? To national saving?