Transcript Module Saving, Investment, and the Financial System

Saving,
Investment, and
the Financial System
What is the relationship between
Savings
• Human capital
• Physical Capital
• The Source of Physical
Capital
SAVING and INVESTMENT
Saving and Investment
Saving = investment in a closed economy
•This is called the saving-investment spending
identity
•When you add government and the foreign
sector, it becomes more intense
SAVING, INVESTMENT, AND THE FINANCIAL SYSTEM
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Budget Deficits and Surpluses impact
investment
Budget surplus
= an excess of tax revenue over govt spending
= T–G
= public saving
Budget deficit
= a shortfall of tax revenue from govt spending
= G–T
= – (public saving)
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Foreign Markets also impact investment
 A dollar generated by national savings and a dollar generated
by capital inflow are not equivalent.
 Investment spending financed by capital inflow comes at a
higher national cost (the interest that must eventually be paid
to a foreigner), than a dollar borrowed from national savings.
THE INTEREST RATE
 The interest rate is the price, calculated as a percentage of
the amount borrowed, charged by lenders to borrowers for
the use of their savings for one year.
Interest Rates and Inflation
What are interest rates? Why do lenders charge them?
Who is willing to lend me $100 if I will pay a total
interest rate of 100%?
(I plan to pay you back in 2050)
If the nominal interest rate is 10% and the inflation rate
is 15%, how much is the REAL interest rate?
Real Interest RatesThe percentage increase in purchasing power that a
borrower pays. (adjusted for inflation)
Real = nominal interest rate - expected inflation
Nominal Interest Ratesthe percentage increase in money that the borrower
pays not adjusting for inflation.
Nominal = Real interest rate + expected inflation
Nominal vs. Real Interest Rates
Example #1:
You lend out $100 with 20% interest. Inflation is 15%.
A year later you get paid back $120.
What is the nominal and what is the real interest rate?
Nominal interest rate is 20%. Real interest rate was 5%
In reality, you get paid back an amount with less
purchasing power.
Example #2:
You lend out $100 with 10% interest. Prices are expected
to increased 20%. In a year you get paid back $110.
What is the nominal and what is the real interest rate?
Nominal interest rate is 10%. Real rate was –10%
In reality, you get paid back an amount
with less purchasing power.
So far we have only been looking at
NOMINAL interest rates.
What about REAL interest rates?
Loanable Funds Market
Is an interest rate of 50% good or bad?
Bad for borrowers but good for lenders
The loanable funds market is the private
sector supply and demand of loans.
• This market shows the effect on REAL
INTEREST RATE
• Demand- Inverse relationship between
real interest rate and quantity loans
demanded
• Supply- Direct relationship between real
interest rate and quantity loans supplied
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This is NOT the same as the money market.
Loanable Funds Market
At the equilibrium real interest rate the amount
borrowers want to borrow equals the amount
lenders want to lend.
SLenders
Real Interest Rate
re
DBorrowers
QLoans
Quantity of Loans
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Loanable Funds Market
Example: The Gov’t increases deficit
spending?
Government borrows from private sector
Increasing the demand for loans
SLenders
Real Interest Rate
Real interest
rates increase
causing
crowding out!!
r1
re
D1
DBorrowers
QLoansQ1
Quantity of Loans
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Loanable Funds Market
Demand Shifters
1. Changes in
perceived business
opportunities
2. Changes in
government
borrowing
• Budget Deficit
• Budget Surplus
Supply Shifters
1. Changes in private
savings behavior
2. Changes in public
savings
3. Changes in foreign
investment
4. Changes in expected
profitability
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Loanable Funds
Market – Handout
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Personal Finance
Assets- Anything of monetary value
owned by a person or business.
Investment refers to business spending.
Personal investments refers to the asset
management of individuals
Liabilities – what you owe
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Bonds vs. Stocks
Bond--Bonds are loans, or IOUs, that represent debt that
the government or a corporation must repay to an
investor. The bond holder has NO OWNERSHIP of
the company.
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Stock –
Part ownership in a company
Stockowners can earn a profit in two ways:
1. Dividends, which are portions of a corporation’s
profits, are paid out to stockholders.
2. A capital gain is earned when a stockholder sells stock
for more than he or she paid for it.
A stockholder that sells stock at a lower price than the
purchase price suffers a capital loss.
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BONDS vs Stocks
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2007B Practice FRQ
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2007B Practice FRQ
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