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Modul Lab 3

The financial system helps match saving with investment, allowing savings to be used to increase productivity and living standards over time. The stock and bond markets are direct financial markets, while banks and mutual funds are indirect financial intermediaries. Saving and investment are important determinants of long-run GDP growth. In a closed economy, national saving must equal investment. Government budget deficits can "crowd out" private investment by reducing the supply of loanable funds.

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26 views

Modul Lab 3

The financial system helps match saving with investment, allowing savings to be used to increase productivity and living standards over time. The stock and bond markets are direct financial markets, while banks and mutual funds are indirect financial intermediaries. Saving and investment are important determinants of long-run GDP growth. In a closed economy, national saving must equal investment. Government budget deficits can "crowd out" private investment by reducing the supply of loanable funds.

Uploaded by

iqbal
Copyright
© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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LAB 3 (CH 26-27)

SAVING, INVESTMENT, AND THE FINANCIAL SYSTEM


• Financial system: The group of institutions in the economy that help to match one person’s
saving with another person’s investment. “When a country saves a large portion of its
GDP, more resources are available for investment in capital that raises a country’s
productivity and living standard (at a later time).”

• Financial Market (Direct)


1. The Stock Market
A certificate that represents a claim to partial ownership in a firm and hence a share of
the profits that the firm makes.
2. The Bond Market
A certificate of indebtedness that specifies the obligations of the borrower to the holder
of the bond.

• Financial Intermediaries (Indirect)


1. Banks
An institution that take in the deposits from savers and use these deposits to make loans
to borrowers
2. Mutual Funds
An institution that sells shares to the public and uses the proceeds to buy a portofolio
of stocks and bonds

• Saving and investment in the national income account


“Saving and Investment are important determinants of longrun growth in GDP and living
standards.”

• GDP Equation
Close economy Open economy
Y=C+I+G Y = C + I + G + Nx

Y=C+I+G
Y – C – G (National Saving (S)) = I
Saving = Investment / (S = I)
or

National Saving = Private Saving + Public Saving


S = (Y–T–C) + (T–G)

Saving = Investment / (S = I)
“In closed economy saving is equal to investment”
• Some Important Identities
National Saving S=Y–C–G
Investment I=Y–C–G
Private Saving Y–T–C
Public Saving T–G
Budget surplus T>G
Budget deficit T<G
Budget balance T=G

• The market for loanable fund: The market in which those who want to save supply funds
and those who want to borrow to invest demand funds

• Loanable funds: all income that people have chosen to save and lend out, and to the
amount that investors have chosen to borrow to fund new investment projects.

• Supply and Demand for Loanable Funds


1. Saving is the source of the supply of loanable funds
2. Investment is the source of the demand for loanable funds
3. The supply and demand for loanable funds depend on the real interest rate (interest
rate)

Source: Mankiw 9th Ed

“When interest rate is high, the quantity of loanable funds


demanded falls as the interest rate rises. And the quantity of
loanable funds supplied rises. Otherwise.”
• Policy 1: Saving Incentives

Source: Mankiw 9th Ed

If a reform of the tax laws encouraged greater saving (Saving


Incentives). the result would be lower interest rates and greater
investment.”

• Policy 2: Investment Incentives

Source: Mankiw 9th Ed


“if a reform of the tax laws encouraged greater investment
(Investment Inventives), the result would be higher interest rates
and greater saving.”

• Policy 3: Government Budget Deficits and Surpluses


1. Budget Deficit is an excess of government spending over tax revenue
2. Budget Surpluses is an excess of tax revenue over government spending
3. Budget Balanced is an equal of government spending and tax revenue

Source: Mankiw 9th Ed

“if the government’s budget swing to a deficit, the result would be


higher interest rates, reduced supply of loanable funds, and the
quantity of investment falls.”

4. Crowding Out is the reduction in investment because of government borrowing.


Many demanders of loanable funds are discourage because of the higher interest rate.
It makes fewer families buy a new homes, and fewer firms choose to build a new
factory. This condition is called “reduction in investment”
“When the government borrows to finance its budget deficit, it crowds out private
borrowers who are trying to finance investment”

• Measuring the value of money:


1. Present Value
The amount of money today that would be needed, using prevailing interest rates to
produce a given future amount of money
Discounting: the process of finding a present value of future sum of money
𝑋
(1 + 𝑟)𝑁
𝑤ℎ𝑒𝑟𝑒 𝑋 = 𝑡ℎ𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑓𝑢𝑡𝑢𝑟𝑒 𝑚𝑜𝑛𝑒𝑦
𝑟 = 𝑟𝑒𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒
𝑁 = 𝑡𝑖𝑚𝑒

2. Future Value
The amount of money in the future that an amount of money today will yield, given
prevailing interest rates
Compounding: the accumulation of money where the interest rates earned remains in
that account to earn additional interest in the future
(1 + 𝑟)𝑁 . 𝑋
𝑤ℎ𝑒𝑟𝑒 𝑋 = 𝑡ℎ𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑚𝑜𝑛𝑒𝑦
𝑟 = 𝑟𝑒𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒
𝑁 = 𝑡𝑖𝑚𝑒

• Managing risks:
A person who is a risk averse dislikes uncertainty. To avoid risks, there are some way
that a risk averse could do:
1. Market of Insurance
Insurance spread the risk among the insurance holders.
o Adverse selection (a high risk person is more likely to apply)
o Moral hazard (after applying for insurance, people tend to have less incentive to
be careful about risky behavior)
2. Diversifications
The reduction of risk achieved by replacing single risk with a large number of
smaller, unrelated risks. Diversifications could lower firm specific risk but can’t
lower market risk
3. Tradeoff between risk and return
The higher the average return, the higher the risk

• Asset Valuation
1. Fundamental analysis
The study of a company’s accounting statements and future prospects to determine its
value
2. The efficient market hypothesis
The theory that asset prices reflects all publicly available information above the value
of an asset.
3. Market irrationality
Asset markets are driven by the animal spirits of investors (irrational waves of
optimism and pessimism)

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