Chapter 252

8/9/2019 Chapter 252

1/54

Saving, Investment,and the Financial

System

Chapter 25

Copyright 2001 by Harcourt, Inc .

All rights reserved. Requests for permission to make copies of any part ofthe

work should be mailed to:Permissions Department, arcourt !ollege Publishers,

8/9/2019 Chapter 252

2/54

arcourt, +nc. items and derived items copyright #-- by arcourt, +nc.

The Financial System

The financial system consists ofinstitutions that help to match one

persons saving with another personsinvestment

It moves the economys scarceresources from savers to borrowers

8/9/2019 Chapter 252

3/54


Financial Institutionsin the U.S. Economy

The financial system is ma!e up offinancial institutions that coor!inate the

actions of savers an! borrowers"inancial institutions can be groupe!into two !ifferent categories# financial

mar$ets an! financial interme!iaries

8/9/2019 Chapter 252

4/54



"inancial %ar$ets&toc$ %ar$et

'on! %ar$et

"inancial Interme!iaries'an$s

%utual "un!s

8/9/2019 Chapter 252

5/54



"inancial mar$ets are the institutionsthrough which savers can !irectlyprovi!e fun!s to borrowers"inancial interme!iaries are financialinstitutions through which savers can

in!irectly provi!e fun!s to borrowers

8/9/2019 Chapter 252

6/54


The Bond ar!et

( bon! is a certificateof in!ebte!ness thatspecifies obligations ofthe borrower to thehol!er of the bon!

IOU

8/9/2019 Chapter 252

7/54

8/9/2019 Chapter 252

8/54


&toc$ represents ownership in a firm an!is therefore, a claim to the profits that thefirm ma$esThe sale of stoc$ to raise money is calle!e+uity financing .

Compare! to bon!s, stoc$s offer both higherris$ an! potentially higher returns

The Stoc! ar!et

8/9/2019 Chapter 252

9/54arcourt, +nc. items and derived items copyright #-- by arcourt, +nc.

The Stoc! ar!et

The most important stoc$ e*changes inthe nite! &tates are the -ew .or$&toc$ /*change, the (merican &toc$/*change, an! -(& (

8/9/2019 Chapter 252


The Stoc! ar!et

%ost newspaper stoc$ tables provi!e thefollowing information#

rice 3of a share4

5olume 3number of shares sol!4

ivi!en! 3profits pai! to stoc$hol!ers4

rice6earnings ratio

8/9/2019 Chapter 252


Financial Intermediaries#Ban!s

'an$s ta$e !eposits from people whowant to save an! use the !eposits to ma$eloans to people who want to borrow'an$s pay !epositors interest on their!eposits an! charge borrowers slightly

higher interest on their loans

8/9/2019 Chapter 252


Ban!s

'an$s help create a me!ium of e*change by allowing people to write chec$s against

their !eposits( me!ium of e*changes is an item thatpeople can easily use to engage intransactions

This facilitates the purchases of goo!san! services

8/9/2019 Chapter 252


Financial Intermediaries#utual Funds

( mutual fun! is an institution that sellsshares to the public an! uses the procee!sto buy a selection, or portfolio, of varioustypes of stoc$s, bon!s, or both

They allow people with small amounts of

money to easily !iversify

8/9/2019 Chapter 252


$ther Financial Institutions

Cre!it unions

ension fun!sInsurance companies

7oan shar$s

8/9/2019 Chapter 252


Saving and Investment in the %ationalIncome &ccounts

)ecall that 8 is both total incomein an economy an! total e*pen!itureon the economys output of goo!s an!services#

Y = C + I + G + NX

8/9/2019 Chapter 252


Some Important Identities

(ssume a close! economy 9 one that!oes not engage in international tra!e#

Y = C + I + G

8/9/2019 Chapter 252



-ow, subtract C an! 8 from both si!es ofthe e+uation#

Y C G =IThe left si!e of the e+uation is the totalincome in the economy after paying forconsumption an! government purchasesan! is calle! national saving , or :ustsaving (S).

8/9/2019 Chapter 252



&ubstituting S for Y-C-G , the e+uationcan be written as#

S = I

8/9/2019 Chapter 252



-ational saving, or saving, is e+ual to#

S = IS = Y C G

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

8/9/2019 Chapter 252


'rivate Saving

rivate saving is the amount of incomethat househol!s have left after paying

their ta*es an! paying for theirconsumption

Private saving = (Y T C)

8/9/2019 Chapter 252


'u(lic Saving

ublic saving is the amount of ta*revenue that the government has left

after paying for its spen!ing

Public saving = (T G)

8/9/2019 Chapter 252


Surplus and )e"icit

If T>G , the government runs a bu!getsurplus because it receives more money

than it spen!sThe surplus of T-G represents publicsaving

If G>T , the government runs a bu!get!eficit because it spen!s more moneythan it receives in ta* revenue

8/9/2019 Chapter 252


Saving and Investment

"or the economy as a whole, savingmust be e+ual to investment

S = I

8/9/2019 Chapter 252


The ar!et "or *oana(le Funds

"inancial mar$ets coor!inate theeconomys saving an! investmentin the mar$et for loanable fun!s

8/9/2019 Chapter 252


The ar!et "or *oana(le Funds

7oanable fun!s refers to all incomethat people have chosen to save an!len! out, rather than use for theirown consumption

8/9/2019 Chapter 252


The supply of loanable fun!s comes frompeople who have e*tra income they want

to save an! len! outThe !eman! for loanable fun!s comesfrom househol!s an! firms that wish to

borrow to ma$e investments

Supply and )emand "or *oana(leFunds

8/9/2019 Chapter 252

27/54

8/9/2019 Chapter 252


Supply and )emand "or *oana(le

Funds

"inancial mar$ets wor$ much li$e

other mar$ets in the economyThe e+uilibrium of the supply an! !eman!for loanable fun!s !etermines the realinterest rate

8/9/2019 Chapter 252

29/54

arcourt, +nc. items and derived items copyright #-- by arcourt, +nc.Loanable Funds(in billions of0

InterestRate

Demand

Su l!

"#

$%&'00

ar!et "or *oana(le Funds...

8/9/2019 Chapter 252

30/54


+overnment 'olicies That &""ectSaving and Investment

Ta*es an! saving

Ta*es an! investment8overnment bu!get !eficits

8/9/2019 Chapter 252

31/54


Ta es and Saving

Ta*es on interest income substantially

re!uce the future payoff from currentsaving an!, as a result, re!uce theincentive to save

8/9/2019 Chapter 252

32/54


Ta es and Saving

( ta* !ecrease increases the incentive forhousehol!s to save at any given interest

rate The supply of loanable fun!s curve shifts tothe right

The e+uilibrium interest rate !ecreasesThe +uantity !eman!e! for loanable fun!sincreases


8/9/2019 Chapter 252

33/54

S

1. Tax incentivesfor savingincrease thesupply of loanablefunds...

&n Increase in the Supply o" *oana(leFunds...

Loanable Funds (in billions of

dollars)

0

InterestRate

"#

Su l!& S !

$%&'00

Demand

$%& 00

3. ...and raises the equilibrium quantity of loanablefunds.

#

2. ...which

reduces theequilibriuminterestrate...

8/9/2019 Chapter 252

34/54


Ta es and Saving

If a change in ta* law encouragesgreater saving, the result will belower interest rates an! greaterinvestment

8/9/2019 Chapter 252

35/54


Ta es and Investment

(n investment ta* cre!it increases theincentive to borrow

Increases the !eman! for loanable fun!s&hifts the !eman! curve to the right

)esults in a higher interest rate an! a greater

+uantity save!

8/9/2019 Chapter 252

36/54


8/9/2019 Chapter 252

37/54

&n Increase in the )emand "or*oana(le Funds...

Loanable Funds(in billions of

dollars)

0

InterestRate

"#

$%&'00

Su l!

Demand& " !

1. An investmenttax creditincreases thedemand forloanable funds...

"

#

2. ...whichraises theequilibriuminterestrate...

$%& 003. ...and raises theequilibrium quantity of

8/9/2019 Chapter 252

38/54


+overnment Budget )e"icits andSurpluses

;hen the government spen!s more than

it receives in ta* revenues, the short fallis calle! the bu!get !eficit

The accumulation of past bu!get !eficits

is calle! the government !ebt .

8/9/2019 Chapter 252

39/54



8overnment borrowing to finance itsbu!get !eficit re!uces the supply of

loanable fun!s available to financeinvestment by househol!s an! firms

This fall in investment is referre! to as

crow!ing outThe !eficit borrowing crow!s out privateborrowers who are trying to financeinvestments

8/9/2019 Chapter 252

40/54



( bu!get !eficit !ecreases the supply of

loanable fun!s &hifts the supply curve to the left

Increases the e+uilibrium interest rate

)e!uces the e+uilibrium +uantity of loanablefun!s


8/9/2019 Chapter 252

41/54

S

1. A budgetde cit decreases

the supply ofloanable funds...

The E""ect o" a +overnment Budget)e"icit...

Loanable Funds(in billions of dollars)

0

InterestRate

$%&'00

Su l!& S !

Demand

"#

$*003. ...and reduces theequilibrium quantity of

2. ...whichraises theequilibrium

interestrate...

#

8/9/2019 Chapter 252

42/54



;hen government re!uces nationalsaving by running a !eficit, theinterest rate rises an! investment falls

8/9/2019 Chapter 252

43/54



( bu!get surplus increases the supply ofloanable fun!s, re!uces the interest rate,an! stimulates investment

8/9/2019 Chapter 252

44/54


The U.S. +overnment )e(t

0

'0

0

0

*0

%00

% "0 % "" % 0 % " % ,0 % ," % *0 % *" % 0 '000 % "

-.S. /o ernmentdebt

8/9/2019 Chapter 252

45/54


Summary

The & financial system is ma!e up offinancial institutions such as the bon!mar$et, the stoc$ mar$et, ban$s, an!

mutual fun!s(ll these institutions act to !irect theresources of househol!s who want to save

some of their income into the han!s ofhousehol!s an! firms who want to borrow

8/9/2019 Chapter 252

46/54


Summary

-ational income accounting i!entitiesreveal some important relationshipsamong macroeconomic variables

In particular, in a close! economy,national saving must e+ual investment

"inancial institutions attempt to matchone persons saving with anotherpersons investment

8/9/2019 Chapter 252

47/54


Summary

The interest rate is !etermine! by thesupply an! !eman! for loanable fun!s

The supply of loanable fun!s comes fromhousehol!s who want to save some oftheir income

The !eman! for loanable fun!s comesfrom househol!s an! firms who want toborrow for investment

8/9/2019 Chapter 252

48/54


Summary

-ational saving e+uals private saving pluspublic saving

( government bu!get !eficit representsnegative public saving an!, therefore,re!uces national saving an! the supply ofloanable fun!s

;hen a government bu!get !eficitcrow!s out investment, it re!uces thegrowth of pro!uctivity an! 8

8/9/2019 Chapter 252

49/54


8raphical)eview

8/9/2019 Chapter 252

50/54

arcourt, +nc. items and derived items copyright #-- by arcourt, +nc.Loanable Funds(in billions of0

InterestRate

Demand

Su l!

"#

$%&'00

ar!et "or *oana(le Funds...

8/9/2019 Chapter 252

51/54


8/9/2019 Chapter 252

52/54

&n Increase in the )emand "or*oana(le Funds...

Loanable Funds(in billions of

dollars)

0

InterestRate

"#

$%&'00

Su l!

Demand& " !

1. An investmenttax creditincreases thedemand forloanable funds...

"

#

2. ...whichraises theequilibriuminterestrate...

$%& 003. ...and raises theequilibrium quantity of

8/9/2019 Chapter 252

53/54

8/9/2019 Chapter 252

54/54

Chapter 252

Documents

Transcript of Chapter 252