chapter 26 saving investment

7/17/2019 Chapter 26 Saving Investment

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Copyright © 2004 South-Western

2626Saving, Investment,

and the FinancialSystem




The Financial System

• The financial systemfinancial system consists of the group of

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 IN THEU.S. ECONOMY

• The financial system is made up of financial

institutions that coordinate the actions of savers

and borrowers.

• Financial institutions can be grouped into two

different categories: financial markets and

financial intermediaries.





• Financial Markets

• tock Market

• !ond Market

• Financial Intermediaries

• !anks

• Mutual Funds





• 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.




Financial Markets

• The !ond Market

• " bond is a certificate of indebtedness that

specifies obligations of the borrower to

the holder of the bond.• #haracteristics of a !ond

• Term: The length of time until the bond matures.

• Credit Risk : The probability that the borrower will fail to

pay some of the interest or principal.

• Tax Treatment : The way in which the ta$ laws treat the

interest on the bond.• Municipal bonds are federal ta$ e$empt.

I!


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Financial Markets

• The tock Market

• Stock represents a claim to partial ownership in a

firm and is therefore% a claim to the profits that the

firm makes.• The sale of stock to raise money is called equity

financing.

• #ompared to bonds% stocks offer both higher risk and

potentially higher returns.

• The most important stock e$changes in the &nited

tates are the 'ew (ork tock )$change% the

"merican tock )$change% and '"*"+.



Financial Markets

• The tock Market

• Most newspaper stock tables provide the following

information:

• ,rice -of a share• /olume -number of shares sold

• *ividend -profits paid to stockholders

• ,rice0earnings ratio



Financial Intermediaries

• Financial intermediaries are financial

institutions through which savers can indirectly

provide funds to borrowers.




• !anks

• 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.




• !anks

• !anks help create a medium of exchange by

allowing people to write checks against their

deposits.• " medium of e$changes is an item that people can easily

use to engage in transactions.

• This facilitates the purchases of goods and services.




• Mutual Funds

• " mutual fund is an institution that sells shares to

the public and uses the proceeds to buy a portfolio%

of various types of stocks% bonds% or both.• They allow people with small amounts of money to

easily diversify.




• 1ther Financial Institutions

• #redit unions

• ,ension funds

• Insurance companies



SAVIN AN! INVESTMENT IN THENATIONAL INCOME ACCOUNTS

• 2ecall that 3*, is both total income in an

economy and total e$penditure on the

economy’s output of goods and services:

( 4 # 5 I 5 3 5 '6( 4 # 5 I 5 3 5 '6



S"me Im#"rtant Identities

• "ssume a closed economyclosed economy 7 one that does not

engage in international trade:

( 4 # 5 I 5 3( 4 # 5 I 5 3




• 'ow% subtract # and 3 from both sides of the

e8uation:

( 7 # 7 3 4I( 7 # 7 3 4I

• The left side of the e8uation is the total income

in the economy after paying for consumption

and government purchases and is called

national saving, or 9ust saving (S.




• ubstituting S for ! " C " #% the e8uation can be

written as:

S $ % S $ %




• 'ational saving% or saving% is e8ual to:

S $ % S $ %

S $ ! & C & #S $ ! & C & #

S $ (! & T & C ' (T & #S $ (! & T & C ' (T & #



The Meanin$ "% Sa&in$ and In&estment

• 'ational aving

• ational saving is the total income in the economy

that remains after paying for consumption and

government purchases.• ,rivate aving

• )rivate saving is the amount of income that

households have left after paying their ta$es and paying for their consumption.

)rivate saving $ (! & T & C )rivate saving $ (! & T & C




• ,ublic aving

• )ublic saving is the amount of ta$ revenue that the

government has left after paying for its spending.

)ublic saving $ (T & # )ublic saving $ (T & #




• urplus and *eficit

• If T * #% the government runs a budget sur+lus

because it receives more money than it spends.

• The surplus of T " # represents public saving.• If # * T % the government runs a budget deficit

because it spends more money than it receives in

ta$ revenue.




• For the economy as a whole% saving must be

e8ual to investment.

S $ % S $ %



THE MA'(ET FO' LOANA)LEFUN!S

• Financial markets coordinate the economy’ssaving and investment in the market formarket for

loanable funds.loanable funds.





• The market for loanable funds is the market inwhich those who want to save supply funds and

those who want to borrow to invest demand

funds.





• oanable fundsoanable funds refers to all income that peoplehave chosen to save and lend out% rather than

use for their own consumption.




S*##ly and !emand %"r L"ana+le F*nds

• The supply of loanable funds comes from people who have e$tra income they want to

save and lend out.

• The demand for loanable funds comes fromhouseholds and firms that wish to borrow to

make investments.





• 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.





• Financial markets work much like othermarkets in the economy.

• The e8uilibrium of the supply and demand for

loanable funds determines the real interest rate.



Fi$*re , The Market %"r L"ana+le F*nds

"oana#le Funds

$in #illions o% dollars&

-

Interest

'ate S*##ly

!emand

/

0,12--

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• 3overnment ,olicies That "ffect aving andInvestment

• Ta$es and saving

• Ta$es and investment

• 3overnment budget deficits




3"licy ,4 Sa&in$ Incenti&es

• Ta$es on interest income substantially reducethe future payoff from current saving and% as a

result% reduce the incentive to save.





• " ta$ decrease increases the incentive forhouseholds to save at any given interest rate.

• The supply of loanable funds curve shifts to the

right.• The e8uilibrium interest rate decreases.

• The 8uantity demanded for loanable funds

increases.

Fi 2 A I i th S l % L +l



Fi$*re 2 An Increase in the S*##ly "% L"ana+leF*nds

"oana#le Funds


-

Interest

'ate

S*##ly1 S , S 2

2. . . . 5hichred*ces thee6*ili+ri*minterest rate . . .

7. . . . and raises the e6*ili+ri*m6*antity "% l"ana+le %*nds.

!emand

,. Ta8 incenti&es %"r sa&in$ increase the

s*##ly "% l"ana+le%*nds . . .

/

0,12--

9/

0,1:--






• If a change in ta$ law encourages greatersaving% the result will be loer interest rates

and greater investment.




3"licy 24 In&estment Incenti&es

• "n investment ta$ credit increases the incentiveto borrow.

• Increases the demand for loanable funds.

• hifts the demand curve to the right.

• 2esults in a higher interest rate and a greater

8uantity saved.




3"licy 24 In&estment Incenti&es

• If a change in ta$ laws encourages greaterinvestment% the result will be higher interest

rates and greater saving.

Fi$*re 7 An Increase in the !emand %"r



Fi$*re 7 An Increase in the !emand %"rL"ana+le F*nds

"oana#le Funds


-

Interest

'ate ,. An in&estment

ta8 credit

increases the

demand %"r

l"ana+le %*nds . . .

2. . . . 5hich

raises the

e6*ili+ri*m

interest rate . . .

7. . . . and raises the e6*ili+ri*m

6*antity "% l"ana+le %*nds.

S*##ly

!emand1 D,

D2

/

0,12--

:/

0,19--





3"licy 74 "&ernment )*d$et !e%icits andS*r#l*ses

• ;hen the government spends more than itreceives in ta$ revenues% the short fall is called

the budget deficit .

• The accumulation of past budget deficits iscalled the government debt.





• 3overnment borrowing to finance its budgetdeficit reduces the supply of loanable funds

available to finance investment by households

and firms.• This fall in investment is referred to as

croding out .

• The deficit borrowing crowds out private borrowerswho are trying to finance investments.





• " budget deficit decreases the supply ofloanable funds.

• hifts the supply curve to the left.

• Increases the e8uilibrium interest rate.• 2educes the e8uilibrium 8uantity of loanable funds.

Fi$*re 94 The E%%ect "% a "&ernment )*d$et



Fi$*re 94 The E%%ect "% a "&ernment )*d$et!e%icit

"oana#le Funds


-

Interest

'ate

7. . . . and red*ces the e6*ili+ri*m6*antity "% l"ana+le %*nds.

S 2

2. . . . 5hich

raises the

e6*ili+ri*m

interest rate . . .

S*##ly1 S ,

!emand

0,12--

/

0;--

:/,. A +*d$et de%icit

decreases the

s*##ly "% l"ana+le

%*nds . . .






• ;hen government reduces national saving byrunning a deficit% the interest rate rises and

investment falls.





• " budget surplus increases the supply ofloanable funds% reduces the interest rate% and

stimulates investment.

Fi$*re The U S "&ernment !e+t



Fi$*re The U.S. "&ernment !e+t

(ercent

o% )*(

,<=- ,;,- ,;7- ,;- ,;<- ,;=- ,=,- ,=7- ,=- ,=<- ,==-

'e&"l*ti"nary>ar

2-,-

Ci&il>ar >"rld >ar I

>"rld >ar II

-

2-

9-

:-

;-

,--

,2-





S*mmary

• The &.. financial system is made up offinancial institutions such as the bond market%

the stock market% banks% and mutual funds.

• "ll these institutions act to direct the resourcesof households who want to save some of their

income into the hands of households and firms

who want to borrow.




S*mmary

• 'ational income accounting identities revealsome important relationships among

macroeconomic variables.

• In particular% in a closed economy% nationalsaving must e8ual investment.

• Financial institutions attempt to match one

person’s saving with another person’sinvestment.




S*mmary

• The interest rate is determined by the supplyand demand for loanable funds.

• The supply of loanable funds comes from

households who want to save some of theirincome.

• The demand for loanable funds comes from

households and firms who want to borrow forinvestment.



S*mmary

• 'ational saving e8uals private saving plus public saving.

• " government budget deficit represents

negative public saving and% therefore% reducesnational saving and the supply of loanable

funds.

• ;hen a government budget deficit crowds outinvestment% it reduces the growth of

productivity and 3*,.

chapter 26 saving investment

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