Transcript Ch. 25 Notes - Solon City Schools

Ch 25 Saving, Investment and the Financial
System
 *p. 553-559 - review of financial terms learned in
Micro stock market lessons
I. Saving and Investments in the National
Income Accounts
*assume a closed economy for now Y = C+I+G (Income
= Expenditures)
 Subtract Consumption and Government from both
sides
Y-C-G = I
 Y-C-G : tells us our income (Y) after we paid for C and
G….so this is National Savings (S)
 …..so Y-C-G = I ……= ……S = I
*think back to AE model ….at Equilibrium , S = I
 …so National Savings = …. S = Y-C-G
 If S = I : how is this coordinated in the economy?????
 THE FINANCIAL SYSTEM TAKES IN A NATION’S
SAVINGS AND DIRECTS IT TO THE NATION’S
INVESTMENTS (p.563)
National Savings is separated into Private and
Public
 *must consider taxes
 Private Income (Y) must subtract private Taxes (T)
and private Consumption ( C )
….so Private Savings = Y-T-C
 Public Income consists of Tax revenue (T) and subtract
Government spending (G)
…so Public Savings = T-G
National Savings = Private Savings + Public Savings
S = ( Y-T-C) + (T-G)
II. Meaning of Saving and Investment
 ***specific use of terms***
III. Market For Loanable Funds
?
Supply Curve:
The Supply of What?
Demand Curve:
The Demand of What?
?
 Supply =
 Savings ….comes from ….
 People have extra income and lend it out
 Examples…
 Savings accounts, buy bonds
 Demand=
 Investment….comes from..
 Households and firms want to borrow to invest
 Examples…
 Home mortgages, firms buy new equipment, factories
 Interest Rates = price of borrowing
 High int rates = Borrowing is….
 more expensive =
 D falls =
 Downward sloping
 High interest rates = Savings is….
 More incentive =
 S increases =
 Upward sloping
Examine Govt. policies that affect
SAVING (S) AND INVESTMENT (D)
Three steps:
1. Shift S or D
2. Direction of shift
3. Evaluate new equilibrium
 Remember: the G taxes all income earned on interest and







can influence the incentive to save by changing the tax on
“interest income” (or dividends, or capital gains)
Ex: G decrease capital gains tax :
or G remove tax on dividends :
or G reduces tax on interest income:
1. shift? - because the incentive affects savings; we
know that Savings = Supply
2. direction? – increase incentive to save = shift S right
3. evaluate – creates lower interest rate ( r ); move
along D curve : and since a lower ( r ) makes it easier to
borrow, and lead to greater investment (*remember I is part
of GDP) = raise eq Q of Loanable Funds
Consider opposite examples
 Taxes and Investment
Ex: what if govt. gave
incentive (decrease taxes) for firms to build new
factories

1. shift? - because the incentive is to increase I, we
know that I = Demand

2. direction? – incentive to increase I = shift D
right
 3. evaluate – creates higher ( r ) ; move along S curve:
and since higher ( r ) makes it better to save = greater
savings. = raise eq. Q of Loanable Funds
 Consider opposite examples
 Govt Budget Deficit (Deficit = more govt spending
than taking in tax revenue) Govt. finance deficits
by borrowing in the bond market.
(*accumulation of past govt. borrowing is called
govt. debt. )

1. shift? Govt. deficit is a reduction of national
savings (private + public savings = national
savings)

2. direction? - public savings is negative so
shift S left
 3. evaluate- creates higher ( r ) ; move along D
curve: and since higher ( r ) makes it harder to
borrow to invest, leads to reduced I (=
CROWDING OUT EFFECT)
 Consider opposite examples
 *when G tries expansionary fiscal policy by increasing
G spending ; but they increase the deficit to do so;
results in higher ( r ) which reduces I spending which
reduces the expansionary effect. = Crowding Out
Effect
 *when G tries expansionary fiscal policy by increasing
G spending ; but they increase the deficit to do so;
results in higher ( r ) which makes dollar
APPRECIATE, which reduces Nx , which reduces the
expansionary effect…….=
Nx Effect
 Consider opposite examples
Note on bonds:
 When a corporation or govt. issues a bond --- investor pays
full price (ex. $1,000)

Earns FIXED INTEREST RATE (every 3 mos. or 6
mos.) (ex. 10%)

When the bond MATURES --- get full purchase price
back
 But – bonds can be bought and sold on NYSE before
maturity.


Example:
Buy bond for $1,000 @ 10% , maturity = 10 yrs,
interest paid every 6 mos.

In one year, you earned $200.
 But --- you notice interest rates have increased (ex.
15%) so you figure you can get better returns on a
different bond. You decide to sell it ,,,,,but who would
buy a $1,000 bond w/ 10%, when they can get 15%.
 To sell it, it is discounted [BOND PRICE DECREASES]
ex- to $800…..
 ….so as IR increase……..
 Bond prices decrease
 Why would I buy this bond?
 I buy bond for $800 , but ….
 I am earning 10% on a $1000 bond
 *****Inverse relationships between Interest Rates
and Bond Prices