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Some examples of financial institutions would be?
- Central Banks
- Commercial Banks
- Credit Unions
- Insurance Companies
What is the definition of non Financial institutions?
Those institutions or organizations that contribute to the national income of the country
Some examples of non financial institutions would be?
- Night Clubs
- Internet Businesses
- Car Rental Agencies
- Fast food outlets
What is the definition of Savings?
- Savings is the withdrawal of funds from the circular flow of income
- In other words savings reduce or redirect funds from current to future consumption
What are the factors in the economic environment that influence the level of savings?
- Rate of Interest
- Level of Income
- Price Movement
How does the rate of interest affect savings?
If rate of interest is high the level of savings should increase and vice versa.
How does the level of income affect savings?
If level of income is high than there will be more money for people to save and vice versa.
How does price movement affect the level of savings?
If people expect that prices will rise they will less likely save and vice versa.
What is the definition of investment?
Investment is the increase in an economy's national income over time.
What factors affect the level of investment in an economy?
- Rate of interest
- Political stability
How does the rate of interest affect investment?
When the rate of interest is high the level of investment decreases. The relationship is therefore inverse.
How does the political stability affect investment?
If the economy is in political upheaval the rate of investment will decrease as people wouldn't have confidence in the economy.
What relationship does Investment have with the rate of interest?
It has an inverse function meaning that an increase in interest leads to a decrease in investment.
What relationship does Savings have to the rate of interest?
It has a direct relationship meaning an increase in the rate of interest leads to an increase in the level of savings.
What is the rate of interest?
The rate of interest is the cost of borrowing someone else's money
What are the two theories that express the relationship between the demand and supply of money?
- Loan-able Funds Theory
- Liquidity Preference Theory
What is the Loan-able Fund Theory?
Changes in the rate of interest may result from changes in investment demands and savings supply.
What is the liquidity preference theory?
Monetary variables influence the demand and supply of money in an economy
What are the motives under the Liquidity Preference Theory that contribute to the demand of money?
What is meant by Transactionary motive?
Individuals needs money for their day to day living expenses.
What is meant by Precautionary motive?
People put aside money for unforeseen circumstances
What is meant by Speculative motive?
People make a capital gain by selling and buying bonds on the open market (Investment)
What relationship does the tranactionary motive have on the demand for money?
It is perfect interest inelastic meaning that changes in the rate of interest does not affect the demand for transactions
What relationship does the precautionary motive have on the demand for money?
It is perfect interest inelastic meaning that a change in the rate of interest does not affect the demand for unforeseen circumstances.
What relationship does the speculative motive have on the demand for money?
There is an inverse relationship meaning the as the rate of interest increases the demand for money decreases for speculative reasons.
What is the other component of the Liquidity Preference Theory?
- It is the supply of money in the economy.
- It is taken as a fixed variable in that the supply of money is determined by factors outside the system such as Fiscal and Monetary Policies.
What is the Monetary Policy?
Instruments available by the Central Bank in order to control money supply.
What are the five common Monetary Policies used by the Central Bank?
- 1.Open Market Operations
- 3.Minimum Lending Rate
- 4.Reserve Ratio
- 5.Lending Purposes
Under the monetary policy what is Open Market Operations?
- This is the buying and selling of government security on the open market.
- It could be either expansionary or contractionary, if the government sells security to the public it reduces the money supply and vice versa
Under the monetary policy what is Funding?
- This is where Short term governement securities are made long term.
- This process is contractionary as it reduces the money supply in the economy.
Under the monetary policy what is Minimum Lending Rate?
- Commercial banks borrow money from the Central bank at a minimum lending rate.
- This can be expansionary or contractionary, if the Central bank increases its minimum lending rate it reduces the money supply and vice versa.
Under the monetary policy what is Reserve Ratio?
- By law all banks are to keep a percentage of their deposits with the Central Bank. This can be contractionary or expansionary
- If the Central bank increases its reserve ratio it is contractionary as it reduces the supply of money in the economy.
Under the monetary policy what is Lending Purposes?
Central bank advises Commercial banks of to lend and not to lend for particular purposes.
What is the Fiscal Policy?
Governments budgeting policy, government revenue and expenditure patterns
What are the different types of revenue & expenditure under the Fiscal Policy?
- Budget Surplus
- Budget Deficit
- Balance Budget
What is a budget surplus?
- This is when governments revenue exceeds its expenditure
- This is contractionary as it reduces the money supply in the economy
What is a budget deficit?
- This is when governments expenditure exceeds its revenue
- This is expansionary as it increase the money supply in the economy.
What is a balance budget?
This when governments expenditure and revenue are equal
What does the IS curve represent?
- The IS curve defines the goods market
- It has as inverse relationship between rates and income.
What causes a shift in the right of the IS curve?
- Increase in investments
- Increase in consumption
- Increase in government expenditure
What causes a shift in the left of the IS curve?
- Decrease in investments
- Increase in savings
- increase in taxtaion
What is the LM curve represent?
The LM curve represents the money market
What causes a shift in the left of the LM curve?
- Decrease in money supply
- Increase in price levels
- Increase in the demand for money
What causes a shift in the right of the LM curve?
- Increase in money supple
- Decrease in price levels
- Decrease in the demand for money
When does equilibrium occur in the economy?
It occurs when the money market (LM curve) and the goods market (IS curve) intersect.
What is the definition of inflation?
Upward and progressive rise in the general price level over a period of time
What are the three types of inflation?
- Cost push
- Demand pull
What is cost push inflation?
Cost of factors that are used in production thereby increasing the final price
What are some solutions to cost push inflation?
- find alternative resources
- hire price control officers
- find different low cost way of producing commodities
- acquire subsudies
What is demand pull inflation?
Demand is greater than aggregate supply at full employment
What are some solutions to demand pull inflation?
- Import supplies
- Find substitutes for high cost items
- Increase taxes to reduce demand
- Increase production
What is Monetary inflation?
- PT =MV
- P=price level
- T= transactions
- M= money supply
- V= velocity of circulation