Chapter 7 Finance, Saving and Investment
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The activity of providing the funds that finance expenditures on capital.
What we use to pay for goods, services and factors of production and to make financial transactions
Tools made in the past that are used today to produce goods and services.
The funds firms use to buy physical capital
Total amount spent on new capital
Gross investment minus depreciation, which is the change in the value of capital.
Value of all the things that people own
Income not paid in taxes or spent on consumption goods.
The main source of funds used to finance investment. These funds are supplied and demanded in three financial markets. Loan, bond and stock markets.
loans from banks for businesses, mortgages for homebuyers, and credit cards, for example.
A bond is a promise to make specified payments on specified dates.
A stock is ownership claim on a firm
- Commercial Banks
- Government-Sponsored Mortgage Lenders
- Pension Funds
- Insurance Companies
An institution’s net worth is the difference between the market value of what it has lent versus what it has borrowed.
- If net worth is + the firm is solvent
- If net worth is - the firm is insolvent
Interest rates and asset prices
Interest rates are inversely proportional to asset prices.
If price of bond increases, the interest rate on that bond decreases
Real Interest Rates
Adjusts for inflation – the borrower pays back with dollars “worth less” than originally borrowed.
The opportunity cost of loanable funds
Nominal interest rate
the actual payments from a borrower to a lender as interest
Demand for loanable funds determined by
- 1. The real interest rate
- 2. Expected profits
Supply of loanable funds determined by
- 1. The real interest rate
- 2. Disposable income (more income means more saving)
- 3. Expected future income (higher future income means less saving today).
- 4. Wealth effect (more wealth means less saving today)
- 5. Default risk (risk that a loan will not be repaid; less willing to supply funds if default risk is higher).
Government budget surplus
- Increases the supply of funds
- Real interest rate falls
- Private saving decreases
- Investment increases
Government budget deficit
- Increases the demand for funds
- The real interest rate rises
- Private saving increases
- Investment decreases - is crowded out
- A budget deficit increases the demand for funds.
- Rational taxpayers increase saving, which increases the supply of funds.
- Increased private saving finances the deficit. Crowding-out is avoided.
If a country’s net exports are negative
the rest of the world supplies funds to that country and the quantity of loanable funds in that country is greater than national saving
If a country’s net exports are positive
the country is a net supplier of funds to the rest of the world and the quantity of loanable funds in that country is less than national saving
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